Valvoline Inc. (VVV) Earnings Call Transcript & Summary

Good afternoon, everyone. We're going to get started here with, I think, the last session of the day. Valvoline here. Pleasure to have you guys with us today. Thanks for coming. Valvoline, for those of you that are not familiar, they are a leading automotive services platform. They offer oil changes as well as other preventative maintenance services. About 2,100 locations today, a little over half are franchised. With us today is President and CEO Lori Flees. Lori joined the company a little over 3 years ago. Been CEO since October of '23. And we're fortunate to also have Kevin Willis, who is the company's new CFO. I think you've been on the job for what, less than a month? Hopefully, everyone took it easy on you today. So -- but this is going to be an open Q&A. If anybody wants to ask a question, you can send one through the iPad, and I'll work it into the discussion.

Lori, just start with you, maybe a higher-level question. Just any observations since you've been in the CEO role for the last 2 years? Like what's special about the business? Why do you think the business wins in the marketplace?

Yes. Thanks for having us, Mark. I've been in the company for 3 years, and I can tell you, I'm just as excited about the opportunities for growth now than I was when I joined. There are three reasons that drive this. First, our industry is incredibly resilient, with a lot of positive tailwinds that we can take advantage of. Whether it be miles driven increasing, complexity of vehicle increasing, age of the vehicle increasing, all of those bode well for ticket and transaction. But also the shift to convenience from the consumer standpoint, which our channel is relatively low penetration. 20% to 25% of oil changes that are done for customers are done in our channel. So a lot of upside in a very resilient market. But Valvoline also has built some amazing capabilities that I think give us the privilege and the opportunity to over-deliver relative to the industry. So our brand is almost 160 years old, it denotes quality. That is a great entry point. But it's the capabilities that make our relationships with customers sticky. Our customer experience is the best in the industry with customers rating it 4.7 stars out of 5 across our 2,078 stores, and that's serving over 1 million customers over the past 12 months. We also have amassed a great data set on our customers, but also on our real estate. Why does that matter? Because our marketing is fueled by the customer data that we have. It allows us to not just keep in touch with customers, to ensure that they come back to our stores when they need service. But also, it allows us to optimize our marketing spend. On the real estate side, we've been building real estate analytics capability, which give us the opportunity and the ability to pick the best locations that drive the best return. So those things take time to build. It takes scale to build and we certainly take advantage of them. And then the third is we have only 5% market share. I commented earlier today I look forward to when I can say 6%. But on our base, we're growing very quickly, but still only 5% market share, our stores cover only 35% at max of the population of the car park. And that's assuming that we're perfectly matched in capacity to the car park, which isn't the case. So a lot of white space opportunities and a group of very strong and loyal franchise partners who've been with us on an average between [AUDIO GAP] 20 and 25 years. Who have upped their commitment and are driving more growth in our business, which means higher return on invested capital while we grow the network in an accelerated fashion. So, so much to be excited about in terms of the potential for growth and shareholder return.

A lot to dig in there. But first, Kevin, maybe just turn it over to you. Your background? What attracted you to this role? And then what are some of the identifiable opportunities you see from a value creation [indiscernible]?

Certainly. Certainly. And I think probably most people know, but I spent the vast majority of my career at Ashland, which was the parent company of Valvoline, for many, many years. Ashland took Valvoline public in 2016, spun it out in 2017. So I've known this company for a really, really long time and have admired it as it has generated very consistent and predictable growth over the course of many years. And I would say the opportunity in front of us is to do the same for many years to come. That's a huge attraction for me to be part of a very exciting growth business. So it's a great business, but also just as importantly, it's a great team and a great culture. I've known that for many, many years. And the time that I spent as part of this process to join the company in the scant two-and-a-half weeks I've been here, as an employee, has only reaffirmed all of that. Yeah, I'll echo some of the things Lori said. We're in a space with very small market share, to our credit. This company has grown leaps and bounds since it was spun out of Ashland, which was certainly the intent at the time. And as I look at the future, what's been developed internally around tools and technology and team, is second to none in the industry, and should help us create a platform that is much, much larger and much, much more profitable than where we are today. And by the way, the profitability of the platform today is quite high. ROIC, top line growth, bottom line growth, overall margin, it's really hard to argue with the metrics and where the team has taken this company. And frankly, we're at a point now from a critical mass perspective to be able to only make that better over the course of time.

Lori, you mentioned the market share 5%, maybe approaching 6% today. How does that compare in these markets where you have density? And how does that inform your view of what the ultimate kind of opportunity set for the number of locations you might have over time looks like?

Yes. So in our more mature markets, once we've been in for a long time, we're approaching 20% market share in those markets. So when you have an average of 5% across the entire U.S. as an example, and you have some markets that are approaching 20%, you know there's a significant amount of upside. And it's part of the reason why we focus on infilling markets where there is -- we don't have enough presence, because the return when you infill a market is pretty high. You get to maturity faster on a new unit and the margin is better because you're leveraging the marketing dollars in that market more efficiently.

I want to talk about network growth, a key pillar of the story. You've laid out, what I think some might have considered aggressive, or ambitious goals. Going from 150 new units to about 250 by '27, with a big focus on accelerating franchise component of that. So just how are you tracking towards those goals? What does the pipeline look like today? And how does that break down between company and franchise locations?

Yes. When we laid out those goals, it was in Q4 of 2022 and we were growing between 40 and 50 units, new units, on the franchise side, and we're around 60-65 on the company side. And we felt that, again, because of our density and because of just market coverage was low, there was a lot of opportunity. And we stated a goal that we could see a path to 3,500-plus units. But in order to do that in a reasonable amount of time, we needed to increase or accelerate the new unit ramp. So we -- we were on pace on the company side to get to 100 by this year. We're definitely on pace for that. And really, it was about accelerating the franchise growth from about 50 a year to 150 a year. And we knew that, that ramp would come slowly and accelerate over time. That certainly is the case and we're ramping up relatively quickly. This year, we'll add between 150 and 185 new units between company at 100 and franchise the balance. And the reality is the pipeline couldn't be stronger. And so, that's been really exciting, but you've got to do it in a paced way. On the franchise side, we've always talked about 2/3 of the 150 coming from our existing franchise partners. And that's where a lot of the growth that you'll see coming through this year has come from. But really, what's been exciting is the number of new partners we've added to the system and that contributing roughly another 1/3.

And you wouldn't be seeing this demand from your franchise partners if it wasn't for the unit economics of the stores. So maybe just talk about the investment outlay, how a store opens up, the ramp to maturity, and ultimately, what type of cash-on-cash return profile do these units generate for your franchise partners?

Yes. So when we have a new unit that comes out, it typically matures between 3 and 5 years. Now if it's an acquisition, or if it's an infill market with good presence, it will be closer to the low end of the range. If it's a market that has less preference and it's a ground up that we're really building demand from zero, it will be to the higher end of that range. We have been accelerating the first year through a bunch of initiatives around early marketing in an area, and that's proved really successful. The reality is when you step back, whether it's an acquired store or a ground up, we look at a 30% cash-on-cash return, which from an IRR modeling on a ground lease is mid-teens, mid- to higher teens. And so really attractive investment for either company to make, or our franchise partners to make.

Re-franchising. You've done a few transactions here over the past 12 months. The rationale behind that, how do you decide what territories to re-franchise? And then -- and just ultimately, it's more than just what you sell the store for, right? So maybe outline kind of the longer-term value creation opportunity with re-franchising? How you think about that?

I think the first important thing is to step back and say, we looked at how much more potential there was in our network and how we would get there. And when we looked at markets that were already being developed by franchisees versus company, and we looked at how much development opportunity there was on company and what our capacity was from a quality of real estate and construction build-out, as well as being able to develop and deploy the team, we knew that there was more white space development opportunity than company was going to be able to do on its own. And so we really did want to focus on ramping up franchise partners, both existing and new. One, because of the territories they already had, but also territories that were being developed fast enough or within the keeping of the demand from the consumer. So we were quite open that we wanted to recruit new franchisees. We didn't need a lot of them. We just wanted a handful. And we were, I think, pleasantly surprised at the number of parties that were interested. Now when you think about re-franchising stores, it is a math equation in terms of driving shareholder value from it. First of all, you've got -- these company stores are well performing. So when you go and buy independents, we know there's upside when we take over an independent by quite a big amount. But when you have a company that's already operated by Valvoline, with the Valvoline branded, all the assets and technology, the upside in performance is relatively limited. So you're asking a party -- another party to spend on the high end of the range of what things are trading at -- trading in the market, not us trading in terms of share price multiple. But when you look at where you expect them to pay, they're paying at the high end, and they're also asking them to develop the market. And the way that the math works out for them is the development has to create the return because they're paying a premium for the asset that they're buying to start. So the return for them is all driven by the upside in a development agreement, which is exclusive rights to develop the territory. Now for us, the way the math works is, there's a purchase price that we get at the transaction. Then there's a development agreement, which also they pay for, and it sets up how many units that they're going to develop over time. Now some will say -- so you do that math and you say, okay, that generates a return for shareholders based on the price that they're willing to pay and the number of units they're going to develop. But what if they don't develop them? Then you're losing money because you're basically selling an asset at a discount for your valuation. So how do you ensure that you get the return? That's where the incentive changes that we put in place a couple of years ago come into play. We actually have a piece of the incentive that we offer our franchisees, which is around having a development agreement and having it be in good standing. What does that mean? The higher they commit to development over a 5-year period of time, the higher incentive they get. What does that mean in terms of incentive? It is a discount on the product cost that we sell them. It affects all of the gallons of lubricant that they buy. So when you have a development agreement and you space out exactly what units they have to have open over a period of time, and you tie it to the incentive, there's real carrot and stick to stay on track for that. Meaning, if in a quarter, they don't hit their numbers, you pull away that lubricant incentive, which is meaningful for [indiscernible] EBITDA performance. So the incentives are in line. They're only going to commit to that which they really believe they can do because they take too much money off the table if they don't deliver. Yet they don't want to under-commit and leave money on the table. So it creates the right tension and it ensures that we preserve the value of the deal. We'll either get the value from the new stores that are opened, or we'll take the value from the incentive. But net-net, we are protecting the value that's created for shareholders. It's part of the reason why in Q3, we talked about the development that had happened in the three transactions because our partners are ahead. These are meaningful incentives that they don't want to leave on the table and therefore, they're trying to get ahead of those, which makes our math even better. So we're really excited about re-franchising.

Oh, that's a great overview. . .

At least the ones that we've done. We don't have a lot more to do. We don't have any plans just to be clear, for more re-franchising. They came together quite quickly, which was where the surprise was.

And then Breeze acquisition announced in February, 200 locations. Rationale, opportunity, confidence in closing the deal because you have received a second FTC [indiscernible].

Yes. I mean this is an acquisition we were very excited about. In our space, there are very few operators that operate 100 units or more, and do so in a high-quality way, that will actually come on the market. In our view. And so, Oil Changers was one of those. It actually traded hands between private equity partners more than 3 years ago. We knew that given the timing of the funds that had -- that Greenbriar had investing in this business, we knew that it was going to be trading within a certain 12-month period. It came a little earlier than we thought, but the decision around when to sell an asset, and a private equity firm is not something we're an expert on, but we were happy to take part of. The reality is, again, 200 units that are highly complementary with our network means there's a lot of synergistic value that you can get. You're looking at a private equity-owned asset that does not build the capabilities that I talked about at the beginning, from a marketing, from a real estate analytics perspective, from a fleet sales perspective. These are things that they were not going to invest in to the extent that we have and scaled. So there's a lot of upside in those units. And in many locations, there's not a lot of open greenfield space to develop. Northern California is fairly built out, the way that you can drive share gains in that area is to start with an acquisition and then build those stores up from a volume standpoint. So super excited about the opportunity. We're a little surprised by the second request, given we have 5% market share. But the reality is when -- now that we've talked to the FTC, I think we have a better perspective. There's not a lot of deals that hit an HSR review for this industry. So relatively new. There was -- with the change of administration, some changes in staffing. And they also changed the HSR requirements such that a lot of companies put in HSR approval requests right around the time that we did. So there was a peak demand, a trough in staffing, a new industry to look at. And the reality is, is it is the FTC's responsibility to ensure that competition is preserved in the market and consumers are not harmed. So a lot of their questions are because they don't know the space and we need to educate them, but still super excited, but our focus is to get through that FTC second review process.

Good to hear. Let's talk about same-store sales. I think the business has compounded close to 10% over the last decade. Breakdown kind of the drivers between transactions, share gain, cars served per day? Some of the structural drivers of average ticket? And then I'll throw one more in there. Just the difference between the guidance this year of 5% to 7%, and you've had this long-term algo out in the market for a few years of 6% to 9%. So maybe explain the delta between the long-term algo and the guidance position?

Yes. There's a lot in there. So, [indiscernible] make sure I cover it all. First, I'll start, when we set the long-term algorithm of 6% to 9% same-store sales growth, it was in Q4 of 2022. So we're almost 3 years in and the economic cycle that we're in looks very different than it did back then. At the time we said it, we had delivered 11% same-store sales in that year and the following year was a little over 9%. So pretty high. But when you look at the mix of transaction contribution and ticket contribution, it was largely ticket-driven, because there was a lot of inflationary price -- cost increases that, from an industry standpoint, not just us, but the industry was passing through to the consumer. And we expected that, that was going to continue for a period, but that, that would start to come down to more normal inflationary levels. And I think as we looked at the guide of 5% to 7%, you're looking at more normal inflationary levels. I think we were hesitant to try to put in tariffs. At the time, there was a lot of talk around tariff increases and what that would mean to pricing. At the time, we know a lot more around tariffs. And the impacts will be pretty minimal for us. So I think part of it is when you look at it, the go-forward for this year we expect it to be much more balanced between transaction and ticket. When you look at transaction growth, we have maturing stores that contribute to the transaction growth. We have fleet sales and a number of marketing initiatives that drive transaction growth. So those remain the same as what we would have talked about 3 years ago, there's still a lot of upside from a transaction growth perspective. On the ticket, there are three primary drivers. Again, one of those, I think, has changed, the others have not changed. Premium mix is a major tailwind for the industry. That's as new cars start to cycle into the car park, the number of them that require full synthetic lubricant is higher, and that has a higher ticket price, and therefore, we benefit from that. Second would be non-oil-change revenue services, which have been a really big tailwind for us, but it's been one we've been working on. It hasn't just been given to us. And this is around making sure that every customer that comes in knows the services that are recommended for their vehicle, and we've got both the equipment, trained staff and the inventory to deliver them. So a lot of the work we've done there is, I think, low-hanging fruit, but there's still more upside when you look at the cars that actually come into our stores, what services they need and what percentage do we actually do? So there's still a lot of upside there, and we're looking at various investments, whether it be training, technology, equipment, things like that, to unlock those. And then the third is net pricing. That's a combination of our posted price but also the discounting. And we've done a lot of work from a marketing personalization and I think transitioning our marketing data into the cloud will allow us more efficient personalization of discounting to our active customer base. It also will allow us to do things to make sure that existing customers aren't getting new customer discounts and things like that. It also allows us to make sure our operators are not misusing discounts in the stores. So a number of those things. And then there'll be price inflation. We have been making price changes while it hasn't been a significant -- as significant of a contributor to the comp, it was in the last quarter, one of the more significant contributors to our same-store sales comp from the ticket standpoint. And it will continue to be. We look at pricing on a regional basis. We look at it -- we benchmark it relative to competition. We do A/B pricing tests all the time. We're looking at elasticity, and we're looking for trade down that it might create. If you create too much of a delta between MaxLife, or our mid-grade synthetic and full synthetic, you could have a 10 basis point trade down to MaxLife. So we look at all of those on a detailed basis before we make any changes to pricing, but it will continue to be a contributor to the comp.

I think you covered it all there.

It's a lot.

You mentioned economic cycle, though, so I do want to ask, are you seeing any behavioral changes today amongst your different consumer cohorts, maybe by income quartile?

While I think it is well understood that there's a lot of uncertainty in consumer confidence, while there are indications it may be rebounding have definitely declined over the past several months. As it relates to our consumer, I think the trade down is on buying a new car, or upgrading to a new car. So for us, people are wanting to maintain the vehicles that they have for longer. And so we do not see them trading down in terms of the type of lubricant they're using, or the number of services they're adding. We see them -- the interval is staying relatively constant. And the percentage of non-oil-change revenue services is going up. So people are wanting to spend more to maintain the asset they have and the trade down is they're not trading up into a new vehicle, whether it's a newer vehicle or a brand-new vehicle. So I think that's perhaps more of the trade down from a full industry perspective, but we don't see trade down or deferral from our customers.

That's good to hear. I want to pivot to margins and specifically SG&A. The SG&A has ramped here the last few quarters. Maybe explain what investments you're making? What -- the cadence of that spend looks like here over the balance of the year? And then just the productivity benefits, or the cost efficiencies that you expect to realize from this investment spend?

Yes. So we have increased our spending on technology. It was something that we talked about. It was something that's going to drive margin accretion over time. In our long-term algorithm, we talked about really driving margin expansion, moving from 26% to 29%. That's still very much is the plan, and that will happen over time. But we do have to invest in technology. Some of that was technology to separate our products business and create -- take end-of-life ERP and HRIS systems and put them on new retail-specific platforms, which will give us opportunities for more efficiency. And when you look at the spend that started in Q3 and Q4 of last year. So we'll start to lap it. When you look at spending in the first half of the year, about 1/3 of the increase in SG&A came from those technology investments. Some of that was new licensing costs from a new ERP and HRIS systems. Some of that was cloud, cloud computing costs and amortization of cloud computing costs. So some of it was just changing to create less hardware in our stores and move to more cloud-enabled systems. So those will have benefits over time that was all factored into the algorithm when we talked about margin expansion, and we would still expect to see that. We don't have those kind of step-up plans contemplated to continue. We knew that there would be a step-up in this year. Unfortunately, that came when we also sold revenue from our re-franchising efforts. And so when you look at the percentage of SG&A, it had the double whammy effect on that.

Is it reasonable to assume you get back to leveraging SG&A. . .

Absolutely.

Yes. Absolutely

. . . on this growth -- low double-digit growth rate next year?

Absolutely. We do not anticipate, and never did, over the 5 years that we would need to grow SG&A at the same rate of sales. I mean that would be -- that would be a lot of SG&A spend growth. Although this year, we knew -- given the re-franchising year-over-year growth would be muted, and we knew we needed to replace ERP and HRIS that were going end of life. Those things sort of came at the same time, which created the reset year. As we move forward and we start to lap some of those increases and we lap the re-franchising, we fully expect to be back on the algorithm we talked about, which is growing profit faster than sales.

That's good to hear. A question from the audience back on the NOCR. Just the attached rate of non-oil-change services, how variable that is across the chain? How much more additional room do you have to take that attach rate higher?

Yes. What's great is we've been quartiling the stores since I got here, and there has been sort of a 3x to 4x difference between our low quartile stores and our high quartile stores. What's interesting is our highest quartile stores are typically the highest for OCPD. So it's not like they have more time to do the services. They're just good at everything. And it also isn't tied to demographic information. So really, it's around operational execution, but there is sort of a 3x -- if you could get everybody to your top quartile, it would be quite a massive improvement. Do we think, well -- I mean, retail is retail. You'll never get everybody to 100% performance. You'll always have differences. And the great thing is our top quartile stores have also improved. So they keep resetting the bar to what's possible and the lower end keeps improving. So there's still significant upside.

Okay. And we have another question here around just how you're positioning the business for evolving vehicle maintenance needs and the increased proliferation of either hybrids or fully electric vehicles?

Sure. I mean if you asked me 3 years ago, I would have thought we would be further along in the journey of the market to EV. But certainly, with the administration change and some of the incentives around EV purchases likely going away, it has definitely slowed the car park evolution. But the way we look at it is consumers are always going to go to the best technology choices for the dollars that they want to spend. And so we know that the car park will evolve at some point. We think it will push out beyond 5 to 10 years, but we still think there'll be evolution. What isn't going to change is the customer's desire to continue to maintain a vehicle or an asset. Unless the assets become significantly less costly, people are going to want to maintain the asset's life for as long as they can. So they're going to want to do maintenance. Two, they are not going to want to do it in an inconvenient way. They're still going to want to do it in a quick, easy way with someone that they trust. And third, I think it's very difficult to see how the dealer channel, even with new EV OEMs, are going to be able to change their model to do it in as convenient way as what we do at Valvoline. So for us, it's not about whether, it's about when. And it's about how we evolve our menu to serve the needs of the technology that the consumers choose.

Okay. We'll wrap it there. Please join me in thanking the Valvoline team.

Thank you.

Thanks [indiscernible].