VVV - Valvoline: Solid Business At Unattractive Valuation Neutral

2023-08-10 14:40:35 ET

Summary

• VVV reported strong Q3 results with impressive same-store sales growth, it faced challenges in franchise unit growth and narrowed its EBITDA guidance.
• It has a strong and flexible balance sheet post and leaner focus on retail business post its sale of Global Products business.
• We believe VVV's position as defensive play in uncertain macro, however, current lofty valuation leaves limited upside. Initiate at Neutral.

Investment Thesis

Valvoline ( VVV ) is the largest public automotive aftermarket services retailer specializing in oil changes with 1,800+ stores across the US, known for its 15-minute, stay-in-your-car oil change. It sold its Global products business for a juicy $2.65 bn to Aramco and had authorized $1.6 bn of share repurchases from the proceeds (of which it has already returned ~$1.4 bn through direct market and tender offer routes with $340 mn remaining in authorization) to become a leaner pure play automotive services company.

Earnings Corner

VVV reported a mixed set of Q3 results with systemwide sales growing 19% YoY as a result of an astounding 12.5% growth in same-store sales. SSS growth comprised of 40% from transaction growth and 60% in ticket price growth which is expected to balance out going forward as it laps prior period pricing actions. Franchise unit growth slowed considerably with only 1 opening in Q3 compared to average 15 in H1 as management cited construction delays. It expects franchise unit openings to accelerate in Q4 but still it would end the year below its initial outlook for 50-70 franchise openings. It maintained that higher sales volume in Q4 will be offset by lower recovery of waste oil, and we believe EBITDA margin for Q4 is likely to be lower sequentially as the one-time 30 bps benefit from product rebates also wanes.

Gross margins improved to 36.8% driven by pricing actions trending back to its 5-year median levels. SG&A leverage improved driven by a strong sales growth partially offset by investments in advertising and talent to support future growth. Adj. EPS came in at $0.43, up 105% driven by strong EBITDA growth and share repurchase leading to lower share count.

The balance sheet remains strong with liquidity of over $950 mn+ in cash and short-term investments and total debt of ~$1.6 bn. It also intends to repay $613m in 2030 bonds carrying a 4.25% interest rate and due in 2030 which would make it essentially net debt free.

However, the company narrowed its EBITDA guidance to $375 - 385 mn vs. the prior outlook of $370 - $390 mn which was a disappointment as the Street anticipated an EBITDA raise and that led the share counter ending in red. It also announced a succession plan with the current CEO Sam Mitchell due to be retiring, effective September 30th, 2023, and will be succeeded by Lori Flees, current President of Retail services in an anticipated move.

Valuation

VVV trades at a lofty valuation of 14x EV/ EBITDA (Forward) compared to ~8x of its peers. We believe the street assigned a higher multiple given the outsized growth and margin profile compared to its peers. However, we believe with the impact of pricing actions waning in 2024, top line growth is expected to normalize going forward. Also, the shares were supported by the buyback but with most of the repurchases complete we believe the impact on the EPS would normalize. We like VVV's positioning as a defensive stock amid an uncertain consumer landscape, but the current valuation provides limited multiple expansion potential. Initiate at Neutral.

Seeking Alpha's valuation grade assigns VVV a 'D' rating highlighting the concerns around lofty valuations.

Risks to Rating

1) any change in the automotive service spending as a result of a substantial change in the consumer landscape would have an outsized impact on VVV's business.

2) Fluctuations in base oil costs which forms the primary raw material could have a significant impact on its gross margins.

3) Significant shift from internal combustion engines to electric vehicles could pressure VVV's reliance on motor oil and while it has improved its penetration of non-oil service, it still remains too small.

Conclusion

We believe VVV would continue to execute on its rapid unit growth and sales growth potential, although which is likely to moderate going forward. Its strong and flexible balance sheet, razor sharp focus on pure play retail business and margin profile provides a better play amidst an uncertain macro environment. However, we believe there is limited upside potential to the multiple at current valuations. Initiate at Neutral.

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