2023-12-15 00:24:46 ET
Summary
- Monro focuses on car services and tires with 1,298 locations in the US, primarily in the Northeastern region.
- The company has grown through constant acquisitions, spending $931 million on cash acquisitions in the past two decades.
- MNRO has had challenges with the pandemic and high inflation leading to lower sales, along with alarmingly decreasing margins.
- As most of the challenges should subside with market normalization, the stock seems to be quite fairly valued.
Monro ( MNRO ) provides car services and tires with a total of 1298 current locations across the United States, with a focus on the Northeastern U.S. and expansion in Western and Southern parts of the country. Monro's strategy revolves around acquisitions in the fragmented industry - in the past nine years, the company has acquired 429 locations according to Monro's October investor presentation . With the consolidation, Monro also operates with multiple brands, including Monro, Tire Choice, Mr. Tire, Car-X, and Ken Towery's.
Despite a good amount of cash flows used for the acquisitions, Monro has been able to pay out a good dividend - the stock's current yield stands at 3.56% . The stock has still performed poorly in the past decade - Monro's stock has almost halved in price in the period:
Growth Through Acquisitions
Due to Monro's strategy revolving around acquisitions, the company has been able to grow its revenues in a very stable manner. From FY2003 to FY2023, revenues have grown at a compounded annual rate of 8.5% in a mostly arithmetic manner.
The amount spent on acquisitions is significant. In the same period, Monro has spent $931 million on cash acquisitions - compared to the company's enterprise value of around $1.57 billion at the time of writing, the acquisitions make up the majority of Monro's value. The company also sees significant potential in the Western region for further consolidation in FY2024 and forward.
Current Market & Strategy Concerns
As the Covid pandemic began, the United States largely went into a lockdown. As a result, traveled miles in the country plummeted. Although the figures have started to recover after 2020, in 2022 the industry was still very widely below pre-pandemic levels:
As a result, Monro's operational conditions have become more challenging due to lower demand for car repair and new tires. Revenues decreased by - 10.4% in FY2021 as a result of the pandemic, and despite a very good growth in FY2022, Monro's revenues have still continued to trail with a -2.5% decrease in FY2023, and the decreases continuing into the first half of FY2024. After a pandemic recovery, Monro has started to face new challenges from inflationary and overall macroeconomic pressure. The concerning trend can be seen from Monro's quarterly same-store sales, which have slowed down in growth into negative territory in Q2/FY2024.
The recent trend is a bit worrying in my opinion. Most notably, Monro's margins have gone worse from a long-term trend of achieving double-digit EBIT margins. Even prior to the pandemic in FY2019, the company's EBIT margin fell to 8.1%, with further decreases coming afterward into a current trailing EBIT margin of 5.6%. With Monro's same-store sales seemingly trailing, a potential fundamental deterioration in the stores could be concerning. Monro has acknowledged around 300 of the company's stores to be underperforming, with a focus on improving especially the underperforming stores' sales. So far, margins don't seem to have shown signs of improvement; I believe that investors should be cautious about Monro's future margins.
As the current market conditions still seem to be weak, I believe that the margins could have some upside with market normalization. Due to a significant amount of fixed costs in the business model, bringing up the same-store sales seems to be a critical factor in the margins. On the other hand, if the weaker sales are not only due to a weak market, but also due to Monro's fundamentally underperforming stores, the low and decreasing margins could be persistent.
Monro seems to have slowed down the pace of acquisitions to focus on the store improvements - after several years having quite high double-digit millions in cash acquisitions , Monro only had $6.7 million in acquisitions in FY2023, and hasn't completed any acquisitions in the first half of FY2024. In addition, Monro divested its wholesale and tire distribution assets in Q1 of FY2023 for around $102 million - the focus seems to have turned more into a focus on organic performance in recent times. I believe that this move could be good for the company, as improving underperforming stores should be a top priority for Monro. As the market conditions normalize, Monro could turn back into a more aggressive acquisition strategy. With a 5-year average return on equity of 7.41% , a reconsideration of the current acquisition strategy could also be reasonable.
A Reasonable Valuation
To estimate a fair value for Monro's stock, I constructed a discounted cash flow model. In the model, I factor in a small amount of further acquisitions, and normalizing market conditions in FY2025 that boost Monro's revenues and margins - for FY2025, I estimate a revenue growth of 8%, which includes organic growth and a small amount in acquisitions. After the year, I estimate some growth through acquisitions, with the acquisitions stopping eventually into a perpetual revenue growth rate of 2%. With the market normalization, I believe that Monro's margins have some room to improve - for FY2025, I estimate an EBIT margin of 7.3%, 1.1 percentage points above my FY2024 estimate of 6.2%. Further, I estimate a 0.2 leverage for FY2026, making the company's sustained EBIT margin 7.5%. With slowing down acquisitions, Monro's cash flow conversion improves within the years in the DCF model.
With the mentioned estimates along with a cost of capital of 7.77%, the DCF model estimates Monro's fair value at $29.11, around 8% below the stock price at the time of writing. The stock seems to have some very modest undervaluation but easily falls into a margin of safety. Monro could well prove EBIT margins above the DCF model estimate or accelerate the acquisition growth above my expectations.
The used weighted average cost of capital is derived from a capital asset pricing model:
In Q2/FY2024, Monro had $4.8 million in interest expenses. With the company's current amount of interest-bearing debt, Monro's annualized interest rate comes up to 3.27%. Unlike my usual method, I also include Monro's leases in the interest-bearing debts - a great part of the company's interest expenses seem to be related to the leases instead of the company's $55 million in long-term debt. As leases are included in the debt, Monro should have a high debt-to-equity ratio in the future. I estimate a long-term figure of 60%, near the current value. For the risk-free rate on the cost of equity side, I use the United States' 10-year bond yield of 3.98% . The equity risk premium of 5.91% is Professor Aswath Damodaran's latest estimate for the United States, made in July. Yahoo Finance estimates Monro's beta at a figure of 1.13 . Finally, I add a small liquidity premium of 0.3%, crafting a cost of equity of 10.96% and a WACC of 7.77%.
Takeaway
Monro's strategy doesn't seem to have resulted in very good shareholder returns in the past decade. Margins have fallen to a worse level in FY2019 and forward, with revenues falling considerably in recent times. The company is facing currently facing a challenging market, as inflationary pressures drive down sales of new tires - a market normalization could drive a partial earnings recovery. For the time being, I believe that Monro's investors should stay cautious about store underperformance, keeping a close eye on the same-store sales trajectory. The stock seems to be priced for mostly reasonable future expectations - despite the challenges, I believe that a hold rating is constituted.
For further details see:
Monro: Focus On Comparable Store Sales Improvement