DRVN - Driven Brands: Rating Downgrade As The Outlook Has Gotten Murky

2023-08-16 06:59:05 ET

Summary

• I am downgrading my rating on DRVN stock from a buy to a hold due to the murky outlook.
• Declining same-store sales and increased competition are contributing to weaker-than-anticipated demand for Driven Brands.
• I believe there is still potential upside for the stock, but recommend waiting to reassess the competitive landscape before considering a buy rating again.

Summary

Following my coverage on Driven Brands Holdings ( DRVN ), I recommended a buy rating due to my expectation that DRVN would continue to see strong performance as 1Q23 results suggest that growth initiatives remained on track. This post is to provide an update on my thoughts on the business and stock. I am now downgrading my rating from a buy to a hold as the business is seeing increased competition, something that I did not expect to hurt the business so much, especially in its mature areas. Based on my model, there is still upside at this level; however, I lack the confidence that DRVN will be able to grow as consensus expected. Hence, I recommend waiting a few more quarters to reassess the competitive landscape before evaluating if DRVN is worth a buy rating again.

Investment thesis

There are two main factors in these results that led to a precipitous decline of over 40% in the share price. The first is the declining SSS and management's remarks about the fiercening of competition. Softer demand in the US, especially in retail sales, weighed on DRVN's Car Wash segment, causing same-store sales to fall by 4%. In addition to unfavorable weather and macro headwinds, management pointed to increased competition within certain markets as a contributing factor to weaker-than-anticipated demand. Also, nearly a third of their car wash locations in the United States have seen a new competitor open up within three miles in the past few years.

Truthfully, I thought it was fine up until now. The second thing, which is the dealbreaker, was that DRVN's management has mentioned that the company is experiencing increased competition even in markets where its car wash locations are much more mature and located in less desirable real estate. This is a tough point to digest, as DRVN should have a substantial competitive advantage in terms of scale and market presence, such that it should be able to outprice subscale players. The fact that these mature locations saw increased competition has significantly impacted my long-term margin outlook for the business. Simply speaking, this suggests, for one thing, that the car wash market in the United States may be more saturated than was originally thought, which could have an adverse effect on long-term unit growth. Two, rising levels of competition may increase the intensity of discounts and price cuts, putting downward pressure on long-term profits. Management has reduced guidance as a result of this dismal forecast. Revenue is now expected to be $2.3 billion for FY23, with adjusted EBITDA down from $590 million to $535 million.

Long-term guidance for adjusted EBITDA of at least $850 million by FY26 was restated by management, but no details were provided on how this target would be reached from FY23 levels. Thus, I think this is another factor that is frustrating investors who have already taken the -40% hit in share price. Without more information being made available, I believe sentiment will remain low for DRVN.

Valuation

Given the new outlook, I believe the fair value for DRVN based on my model is $19, a big revision from my previous price target of $34. My model assumptions are now based on consensus estimates as I benchmark my model to reflect the market view. Suppose the business grows as expected and valuation continues trading at this level, there is still upside to the stock. However, I think the risk here is that the DRVN disappoints, especially with competition intensifying. Hence, I am downgrading my rating from a buy to a hold and will monitor the next few quarters to see if there is any change to the competition landscape.

The saving grace here is that DRVN's competitor, Mister Car Wash ( MCW ), saw an increase in SSS and also commented that they are gaining share . As such, I think there is a path for DRVN to stay ahead of the competition. Until then, I lack absolute confidence that DRVN will be able to meet consensus figures.

Conclusion

In conclusion, I am downgrading my rating on DRVN from a buy to a hold due to unexpected increased competition, especially in the company's mature areas. While there is potential upside based on current valuation and market view, uncertainties surrounding DRVN's ability to grow as anticipated and maintain margins in the face of intensifying competition prompt this rating change. That said, the positive performance of a competitor suggests a possible path for DRVN to stay competitive, but until then, I don’t see any positive catalyst that will drive the stock up.

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