Valvoline Inc. (VVV) Earnings Call Transcript & Summary

Excellent. Another ticket driver is, of course, the non-oil change revenue. For anyone in the audience who's not familiar, Valvoline provides other services such as changing of batteries, cabin, engineered filters, something of the sort. The attachment rates there have been really great. If we look at your top-performing stores, what are they doing differently from a training or a presentation perspective that's getting that attachment rate so high? And what can we learn from them?

Sure. I think execution consistency is key. Every technician gets the same initial 270 hours of training. The SuperPro process lives in every store. It lives in our point-of-sale system across the entire network. But the execution of that process in a very consistent way is what separates out our top stores from stores that maybe aspire to be better. And as you look at that, it's definitely about doing a consistent thing every time, performing that 18-point safety check every time, even if you're busy, showing the guest the part, the cabin air filter, the result of the battery test, the engine air filter, so that they can become educated about the condition of those and then make that educated choice around that. And again, doing that the same way every time in a way that's not a sales pitch, but here's an opportunity to better maintain your vehicle if you want to do so. I think also another tier is explaining the OEM services. We do offer certain services that the OEM recommends either every certain number of miles or every certain amount of time that passes. And it's being able to explain those services to the guest, show them the benefit of those and also show them exactly and specifically what their OEM recommends and when so that they can be an educated consumer and make the choice. Those all come into play. It's a very intentional process. I think part of what we do really well is the training, staffing consistency, which is also really important and product availability. So don't present a service or a product to a guest that you don't actually have in stock. That's not a good look and so being able to do those things. And we often get asked about, well, would you add other additional services? And things that we can do in the context of an oil change in the context of providing quick, easy, trusted service to the guest that's very consistent, very repeatable, builds a lot of trust. Those are the things that we want to do. It's not about adding services for the sake of adding services. We don't want to do that.

Excellent. Excellent. And the presentation is very real and very tangible. When someone brings out your dirty filter, you see how dirty it is. It's a very real reason for them to purchase it.

And the reality is the difference between great and okay is they show you an engine air filter side by side with a clean one. When they don't show it to you next to a clean one, you're less likely to know how dirty that is. Second, they pull a cabin air filter every time. And then the third one is the retention of our team and their ability to understand what the OEM services are and be able to explain those very easily, but in a non-pressured way to customers. That's the difference between first quartile and average.

Okay. Then switching to acquisitions. So Breeze AutoCare, big acquisition you did. We're going through the integration phase right now. Can you talk about how many stores have been converted to the Valvoline platform right now? And just how those stores have been performing relative to expectations?

Yes. I mean, Breeze AutoCare, while it makes up less than 10% of our stores and our sales, it was the largest acquisition that the company has done in its history. And we couldn't be more pleased with the progress that we've made so far. The performance of the Breeze business on all financial metrics has been at or better than what we would have expected. And I think when you buy something that's large, you're hoping for the best, but you always assume that something will go awry. At the end of Q3, we talked about the fact that we had converted 12 of the 160-plus stores in the portfolio. We really focused on stores that were stranded after the FTC required divestitures because that allows us to gain SG&A advantage, and that was always part of the plan. But when we look at the performance of those stores relative to what we would have expected, they're actually performing better. And I say better on a transaction basis. That's the real piece of it. Ticket typically always can do better, and they have been performing very well, but transaction is usually the test of how much you want to ramp. And as you'll remember, the thesis on the Breeze stores is the value comes by taking their average revenue per sales of $1.1 million up to our average of between $1.7 million or up. And so transaction is a big drive to get that. So, so far, so good, but really early days. We have seen some softness in markets that we didn't convert where we've had to raise prices. So the elasticity that we're seeing with Breeze is probably a little bit higher than with the Valvoline brand. And then I think we've been really pleased on some early delivery of SG&A savings that we had planned. So overall, I think we couldn't be more pleased with the performance. I would say on the conversions, we've really been trying to figure out what's the difference. We do acquisitions every year, about 30 to 35 new units on the company side come from acquisitions. The difference in the Breeze piece is we did wait a while to start the conversion so we could really engage the team and let them understand and appreciate our culture. I think when we did that, as we've converted stores, we have we have not had the attrition that we typically see when we close and convert a store right away. So I don't know if we'll take that approach to independent or operator -- 1 or 2 store operators. But for us, the approach we've taken with Breeze has been really positive.

Excellent. Yes, I'm looking forward to see the platform there. I think it's a great opportunity. I think switching gears a little bit, we'll talk about some of the more macro themes. I'm sure it's been a topic of much discussion in your investor meetings today, and I think it's top of mind for people and definitely very timely. But the oil supply and pricing environment, can you talk about maybe the state of supply environment right now for finished lubricants how supply chain is adapting to some of the shortages? And then maybe at least in my mind, Valvoline sits in a different position than other players because you have such strong relationships with your suppliers. So maybe can you talk about that a little bit as well.

Sure. I think everybody is very aware at this point that just due to the length of the conflict, about 20% of the world's oil supply used to go through the Strait of Hormuz, and that's much less than that today. As we look at how that impacts us, the primary impact that we're seeing is really around Group III base oil. Some of that is due to the fact that there are some Group IIIs manufactured in the Middle East that aren't moving very much, some but not -- and a lot of it, though, is related to that choke point in getting crude to Asia, primarily South Korea, where a lot of Group III base oil is made. There's also been some trade-offs around things like jet fuel and diesel fuel that have impacted supply as well, just the refiners maximizing their own mix. So all of that said, and Group III, just as a reminder, is the primary ingredient for full synthetic motor oil. As we look at that, though, today, nothing has changed from our Q3 earnings call, we don't see -- we don't have any supply constraints today, and we don't see any coming in the near term. You mentioned it, we have a strategic relationship with our supplier. At one point, we were part of the same company. It's been several years since that's been the case, but they're now part of the Aramco family. And there -- the fact that they have been in the motor oil production business for so long, lubricant business for so long means that they have established networks that few in the industry can compare to. And I think a misconception is that because Valvoline Global is part of Aramco, they're obligated to buy all their product from them. That's not true at all. It wasn't true before the transaction. It's not true now. They are out there finding the best product to do what needs to be done to supply their customers, of which, obviously, we are a very large one. So that does help us. So our scope and our scale, the strategic supplier relationship, all good. We are singularly focused on making sure that every guest gets the product and the service that they need when they come through one of our bays. And nothing has changed around that. The execution at the store level is still at a very high level. And at this point, the supply piece is -- I mean it's a distraction, I think, for the world, certainly for our market. But we have a lot of confidence that, again, for now and for the near term, we will have surety of supply for our customers.

Excellent. And as we think about supply constraints, obviously, cost and price comes into the question here. So can you talk about the cost increases that you've experienced year-to-date? And I think as we sit here today, maybe it's fair to assume that we might see some cost increases going forward as well. And then, Lori, I think on the last quarter's conference call, you mentioned that even if everything were to change today and we go back to a pre-conflict sort of environment for supply, the supply chain for Base III would still take a long time to get up and running. And so how could that impact the cost environment as well?

Yes, I'll cover the second part and then come back to cost. But let's assume that the Strait opened today. That doesn't mean that immediately, we're back in business with full supply chain and costs starting to come down. Given the restart that would have to happen and the length of time to get things through the Strait of Hormuz to the next step in the supply chain cycle, you're looking at 4 to 6 months in order for supply to get back into normal bounds. And that's assuming that there isn't any major infrastructure damage, which there has been to some suppliers outside of our scope or outside of the ones that we work with that will take longer to mediate. But you're looking at 4 to 6 months once the Strait is fully open for Group III base oils to be back flowing in the way that they were pre-conflict. So that will take some time. So what have we seen from a cost standpoint? If you take 20% of the global supply out and you further constrain the Group III, there's a few things that have happened. One, people start to look at ways to get other substitutes, not from Korea on Group III. There are several. Re-refined oil is a new one that's growing. But you also look to make trades and formulations to trade off Group III with Group II such that demand is lower. But at the end of the day, prices rise, and that's exactly what we've seen. And we talked in Q3 about how we had started to see some of the pricing -- some of the cost increases and that we expected that the peak to hit us in Q4, the peak that we could see at that time would be 60% higher than pre-conflict. I would say we saw about 1/4, 1/3 of that in Q3, and we started to see that continue to grow. We expect by the time we are finished with Q4, we will see the full 60%. And then we have to think about what's going to come in Q1 as the continued constraints remain. The way that we're looking at it is we have to look at it in 2 pieces. One is on the company store side, how do we pass and what do we pass through to the consumer. On the call, we talked about that 60% increase in finished lubricant as it relates to our ticket because lubricant is a piece of the cost, but not the total. You're looking at a $5 to $7 per oil change cost impact that we had that we have taken already with consumers on the company side. So we actually did that earlier than our historical practice has been. And part of that is because since 2022, when I think many who followed us would have said we were late to make pricing changes, we put in some capabilities and some process, and we, I think, are more fully ahead of how do we make pricing changes when we see the opportunity to do so, not just the necessity, but the opportunity. So as we saw costs starting to forecast to be up, we knew what actions we would take and we took them, and we took -- we end up being a little ahead of it. We don't anticipate and haven't needed to make any other pricing changes for the quarter. We're evaluating based on where cost might go in Q1 and beyond, what our options would be. So we're, I think, continuing to stay ahead of it. But that's on the company side. On the franchise side, we pass and have had a history of passing costs through up and down on a penny basis to our franchisees. And we had some sort of historical operating practices around depending on the magnitude of the cost increases or decreases, there was a timing, so sort of expectations of when those would pass. The reality is the costs were moving so much more quickly in Q3 and moving more into Q4 that we had to engage our franchise partners to talk about changing our normal mode of operating. We normally follow the base oil index. There's a disconnect between actual cost and the base oil index based on where the spot market is and where the market overall is. And so in order to ensure we were passing costs through again on a penny basis, we needed to change that practice. So a, we've been sharing more of the forecast with them so they can incorporate it into their planning for pricing changes and/or any cost investment that they may want to delay. And that allows us to shorten that gap or that time frame. But that is a change in practice that we were in the process of making as we finished our Q3 call, and I think that will serve us very well. It doesn't mean that the timing will always be lined up day for day. So as costs go up and if they go up faster than we forecasted, there might be a lag, but we've been able to get that time lag shorter with the support of our franchise partners and given them more visibility of what's coming so they can plan for it.

And I think what I would add to that is while we will see impact because of that process change that we've been working with our franchise partners in Q4, that was included in our full year outlook that we talked about on the Q3 call. We feel good about where we are on a go-forward basis post Q4 in terms of that pass-through. As Lori indicated, there's always going to be the potential for some timing differences just because of process and updating prices and the systems and all of that. But the objective is to get that to be as tight as possible as quickly as possible.

Well, as we approach time here, we have 4 questions we're asking every company at the conference. There's supposed to be kind of a quick hits, yes, no, maybe same better or worse. Feel free to opine if you want. But the first one is on the health of the consumer. So as you think about the second half of the year relative to the recent results, do you expect them to be the same, better or worse? And I think maybe fiscal year might be better -- I mean, I'm sorry, calendar year might be better than fiscal year for you guys entering the fourth quarter.

What I would say is we're -- when we look at the health of the consumer, we would expect it to be the same, maybe slightly worse. And partly, we based that on some of the softness we started to see in Q3 with the consumer and our growth, and we saw that continue as we've continued into the fourth quarter. And some of that is, I think, driven by macro concerns. Gas prices are up, miles driven are down, that affects transaction timing, but also people being stretched. So preventative maintenance is something they know they need, but the ability for us to acquire new customers getting tougher in this environment. So overall, we see a lot of resiliency with our customers, but there is some softness that we're seeing. So we would say the same, maybe slightly worse as we look forward through the rest of the calendar year.

Excellent. And then pricing, I think I know the answer to that one.

Higher.

Higher.

And then last one I'll ask you is AI. Do you expect any efficiencies in AI in '27 versus 26'?

So we've had a lot of efficiencies already using AI. I mean we are not an industry that is going to be transformed with AI, but there is efficiency in software development and marketing and then in just more in the G&A side. So will it be a step change improvement? No, but we'll continue to get efficiencies using generative AI and just generally.

Excellent. Well, Lori and Kevin, thank you very much. I appreciate it.

Thank you.

Thank you, Mark.