Description

Idea: Long Valvoline, the largest focused pure-play operator in the fragmented oil change industry, which is trading for ~16x our estimate of FY25e EPS. Our bottom-up analysis of unit potential combined with the lack of at-scale focused competitors leads us to believe Valvoline will accelerate unit growth from 140 to 250 openings / year over the next five years. Additionally, we believe the market is understating the durability of a 8-9% SSS growth algorithm, particularly given low-hanging fruit to drive incremental ticket growth. We are 46% ahead of Street on FY27e EPS and see 45% upside. 

Business Overview

Valvoline (“VVV” or the “Company”) started in 1866 as a lubricant wholesale business and was acquired by Ashland (leading Global Chemicals business) in 1950. Valvoline oil change (“VIOC”), the business we are investing in today, was not founded until the late 1980s. The abundance of capital available for reinvestment from Ashland and the Global Products business line allowed VIOC to scale rapidly. Valvoline was spun out of Ashland in May 2016, and the Global Products business was subsequently sold to Aramco in March 2023, leaving the RemainCo as a standalone / pure-play oil change player with over 1,850 locations. 

Valvoline locations generate ~75% of their revenue from oil change services. Valvoline’s brand, accessibility, and quality of service has propelled them to a leading market position in the industry. The remainder of revenue is derived from vehicle safety checks / part replacement (typically done by DIFM auto parts operators like O’Reilly / AutoZone / AAP aka everybody’s favorite value trap). Valvoline’s revenue model is a mix of company-operated store revenue (80 - 85% of Total Revenue) and Franchise royalty / support fees (15 -20% of Total Revenue). Note that the company no longer discloses Company-Operated / Franchise mix and we triangulated to it through a combination of historical figures / FDD disclosures / internal analysis. 

Industry Overview

There are ~430mm – 450mm oil changes performed per year (for a 283mm car parc). Of this, Valvoline estimates ~100mm or 22% are performed by pure play operators such as Valvoline, while the rest is done by auto dealers and repair shops. 

The key pure play oil change operators are Valvoline (~1,850 locations), Jiffy Lube (~2,000 locations), Take 5 (~700 locations), Grease Monkey (350 locations), and Express Oil Change (335 locations). It is worth noting that Jiffy Lube is owned by Shell, and hence likely not a focus for them. Our work indicates that their quality of service and network expansion has been inferior to Valvoline. Take 5 sits within the Driven Brands ecosystem and is ~40% of their segmental EBITDA. 

Household names such as Valvoline and Jiffy Lube have several scale advantages (technological, automation, speed of service, equipment purchases) that enable them to generate outsized ROICs. As such, there is a clear path for a focused pure-play such as Valvoline to capture an overwhelming share of industry unit growth from sub-scale independent operators, auto after-market shops and dealers. 

Investment Thesis 

1. There is a large whitespace of growth for Valvoline to more than double units, providing 10 -15 years of reinvestment runway 

2. Due to its brand and scale advantages, Valvoline should maintain its market leadership and continue to take share from 1) other quick lube operators 2) DIFM auto repair shops 

3. Valvoline has strong structural and idiosyncratic drivers that drive a 8-9% SSS algorithm

Thesis 1) There is a large whitespace of growth for Valvoline to more than double units, providing 10 -15 years of reinvestment runway 

Quick lube penetration, and as such Valvoline’s share of total oil changes, varies largely by region across the US. Valvoline currently only covers 30 – 35% of the US population with 5% share of total DIFM oil changes (across quick lube and auto repair players). 

However, in deeply penetrated markets such as Kentucky, Minnesota, and Tennessee, VIOC’s share of oil changes is ~mid-teens, 3x that of existing markets. 

“As with most retailers, store share drives market share. Today, our market share in our strongest markets like Louisville, Kentucky is over 3x our network's average market share. This relationship is consistent when comparing store share across our network, with our top markets showing that we have significant store infill opportunities in many key markets.” – CEO at Baird Conference, June 2023

The Company has shared a LT unit target of 3,500 units vs. 1,866 today with growth coming from under-penetrated markets like California, Texas, and Florida as well as market share gains. To sanity check this target, we ran a web-scrape of the Company’s store locator and a summary of our location dashboard is as follows: 

Our analysis above on a state-by-state basis indicates that there is significant whitespace available for VIOC unit growth. We size our TAM based on having one VIOC / 30k vehicles, which we view as conservative for a couple of reasons: 

1. Kentucky has one VIOC / 23k vehicles and the Company has cited this as a proxy for what other mature markets could look like 

2. There continues to be an opportunity for share gains from DIFM auto repair shops and auto dealers, so “mature markets” where we underwrite zero unit growth can surprise to the upside

Putting things together, we see an opportunity for at least ~3,700 VIOC locations at maturity with significant upside risk, in-line with the Company’s 3,500 target. It is worth noting that our discussions with formers indicate this was not a fixed target, but rather a medium-term goal post. 

Another driver of our conviction in accelerating unit growth and significant whitespace is that the Company has great line of sight into new franchise opening. Per management, ~70% of franchised stores are concentrated among 5-6 franchisors. Per our checks with one of the larger franchisees, store development agreements are signed 3-5 years before opening. As such, we have a high confidence interval in the Company’s optically aggressive guidance to 3x new franchise openings from ~50 units / year in FY23 to ~150 units / year in FY27. 

Thesis 2) Due to its brand and scale advantages, Valvoline should maintain its market leadership and continue to take share from 1) other quick lube operators 2) DIFM auto repair shops

There are several benefits to being a scaled operators in the quick lube business: 

1. New Store Algorithm: Valvoline has one of the best algorithms to find new store opening locations that has been trained over several years. We think this enables them to find new whitespace before competitors and drive higher throughput per unit. Our conversations with formers confirm this: 

“We got a model, like they model that is built with algorithms where you put in all the demographics and you put in all the sales, existing stores, then you could start generating information to say if I put it here with all these specifics, it's going to do 50 [oil changes] versus if I put it over here a mile down the road, it's going to do 35 or 40.” – Former Senior Director, Valvoline Franchising & Development 

2. Automation / Speed of Service: Valvoline has made technological investments starting with easy scheduling on the mobile app with estimated wait times to back-end training software for employee to drive a streamlined oil change. The benefits of technological / employee training initiatives can be seen in VIOC’s superior speed of service. Our analysis from surveys is below: 

Grease Monkey, which is the only player at a similar scale as VIOC, takes 2x as long to service a customer. Additionally, Take 5 does not offer many non-oil change services, which likely helps their average speed of service. Our VAR corroborates survey data: 

“Take 5 is the 2nd best operator in terms of speed and experience. You're not going to get that at Jiffy Lube in most cases because they're doing too many other things. And Grease Monkey is just a mess, partly because they're kind of more like Jiffy Lube than a Valvoline or a Take 5.” – Former Senior Director, Valvoline

Additionally, we have heard in expert conversations with experts that quality of oil change service at auto repair shops and dealers has gotten particularly worse in recent months given the mechanic shortages. Given oil changes are a low dollar ROIC service for them, these are often put on the backburner for higher ROIC repair / higher dollar value maintenance work. This creates an opportunity for VIOC to further differentiate their value proposition vs. competitors. 

Lastly, we believe the Company is still early stages of driving a more streamlined / automated product offering. Recent advancements include additions of estimated service time to their application and the creation of a central operations team focused purely on driving efficiency. 

"In FY '23, our newly-formed central operations team is working to implement equipment, technology and supply chain solutions that will simplify work in our stores and enable faster service delivery." – CEO 4Q22 EPS Call

3. Equipment / Capex: Given their scale, VIOC is able to gain discount on equipment required to install oil change bays / on maintenance parts as compared individual operators. 

Putting things together, we have heard from industry participants that independent operators do ~35-40 oil changes per day at an average ASP of ~$85. Our highly illustrative swag at unit economics of VIOC vs. an average competitor is as follows: 

Our high-level analysis indicates that independent operator ROICs and as such 4-Wall EBIT are roughly 50% lower than VIOC.  We see these strong economics translate to market share gains, as VIOC’s transactions / location have grown at a ~4.5% CAGR since 2018, while total US vehicle miles has been ~flat, indicating significant share gains. Additionally, even post royalties, which are 6% of gross revenue per the FDD, VIOC franchise ROICs still far exceed independent operator:  

To sum up Thesis (1) and (2), we believe Valvoline has plenty of both greenfield and brownfield for unit growth. As such, we expect unit openings to accelerate over the next five years. 

Thesis 3) Valvoline has strong structural and idiosyncratic drivers that drive a 7-9% SSS algorithm

We believe the structural (aging auto fleet, miles driven) and idiosyncratic (share gains, shift to synthetic fluids, non-oil change revenues, growing fleet mix, and store maturation). We believe the structural drivers almost exclusively drive transaction volumes, while idiosyncratic drivers predominantly drive ticket (but some also drive transaction growth). 

Aging Auto Fleet 

The aging auto fleet helps VIOC on three fronts:

1. Frequency: Older vehicles require more frequent oil changes, every 3 – 5,000 miles as compared to 7,500 to 10,000 miles for newer models

2. Market Share: Most vehicles purchased at dealerships come with free perks that often will include free oil changes for the first few years among other maintenance add-ons. As cars roll-off free dealer maintenance programs, customers will be more willing to try a quick lube provider such a VIOC given the superior product offering

3. Cross-Sell: Simple repair / maintenance such as wiper blade / air filter replacements can be cross-sold with oil changes, as detailed in Q1’24 earnings

“Now the car park is aging, which is a tailwind given many of our OEM recommended services become more relevant with the mileage of the vehicle going up.” – CEO 1Q24 EPS Call

The average auto age has gone up ~1 year to 13.1 years over the last two years, which has been a tailwind for VIOC (Appendix 2) 

Market Share Gains

As discussed in Thesis 2, VIOC has a clear path to continue taking share from competitors. We think this will be a strong driver of ticket growth, particularly given the Repair and Dealership channels (58% of new business) have tighter labor markets: 

We think the share gains and aging auto fleet should contribute to a minimum of 3% transaction growth, in-line with Company guidance (not explicitly guided but can be triangulated into with EPS call disclosures). Additionally, there is sufficient capacity to grow transactions / store, given the Company has guided to 60 transaction / day over the long term vs. 53 today (or 13% incremental capacity).  

Synthetic Mix Shift

Conventional motor oil is derived from simply refining crude oil. Synthetics oil is created with a more chemical process and has fewer impurities, in turn improving vehicle performance and longevity. In addition to an aging car parc needing higher quality motor oil, most new cars require fully synthetic motor oil for optimal performance. Management has called this out as a 1.5 – 2.0% comp tailwind, and we corroborate their findings by analyzing the uplift bottom-up. Our analysis indicates that the comp tailwind from Synthetics will contribute ~1.8% to SSS growth for at least the next 10 years, assuming no underlying inflation. 

We would also note that per 2021 Business Update, Synthetics carry a higher % margin (56.5% vs. 37.5% conventional) and a ~2.9x gross profit $ uplift. As such, the shift to Synthetics will not only be a comp, but also a margin tailwind which is being under appreciated by the market.  

Non-Oil Change Revenues 

VIOC has launched several ancillary product offerings such as battery replacement, radiator service, air filter changes. These drivers have contributed ~1.5% to comp growth over the last few years and our belief through internal analysis and discussions with franchise operators is that there is a real opportunity to accelerate growth on this front. While the Company has captured “low-hanging fruit” on cross-sell, as they train technicians and advertise ancillary offerings, there is an opportunity to grow ancillary mix of revenue from ~24% today. 

“And I would just say while some of the improvements we've made [in non-oil change], I would call low-hanging fruit, we still have a lot of opportunity, and it's just the basic disciplines.” – CEO 1Q24 EPS Call

We believe out of the below ancillary revenue opportunities, Tire Rotation and Battery Replacement are the easiest cross-sell opportunities. 

Growing Fleet Mix 

The fleet business currently comprises < 10% of revenue and is outgrowing the overall VIOC business by 7-10 % points, growing 25% in 2023. We are excited by the Fleet growth because we believe this comes at high incremental margins: 

1. Fleet ticket is 20% higher than consumer ticket, predominantly due to higher non-oil change penetration 

2. Off-peak hour servicing increases capacity utilization 

Additionally, the Fleet growth algorithm is highly predictable given a clear GTM can be deployed to grow accounts. Fleet has contributed 1.5% to comp in recent years and we don’t expect this to slow anytime soon. 

Putting things together, we see a clear line of sight to 5 – 6% ticket growth at least over the next 5 years with upside risk. Combined with 3% transaction growth, we have a high confidence interval for Valvoline achieving the higher end of their 6 – 9% comp growth guide. 

Valuation

In a base case, we model FY27 EPS at $3.98, 46% ahead of Consensus, and as such 45% upside. We additionally give no credit to interim cash generation / buybacks in our upside estimate. Our variance comes from being ahead of consensus on unit, comp, and margin growth. Furthermore, we believe that most of the Street is mismodelling the business as they do not even attempt to break out Franchise and Company store revenues or dissect comp growth into volume / ticket components. This sloppy modelling leads to mismodelling of not only revenue growth but margins, and subsequent Hold ratings from GS and Wells, who are both doing the above. 

Our summary operating model is as follows: 

In a bull case, we give the Company credit for hitting the top-end of their guidance ranges (comp / store growth). This drives $4.64 in EPS, which at 20x wields a $72 stock or 87% upside. 

Our 3-Year Risk / Reward is extremely favorable at a ~ 4x R/R, with our downside case assuming the Company has zero upside to Street: 

Putting things together, we are excited by the opportunity to invest in a ~20% grower at ~16x FY25 EPS on our numbers.

Risks

• Underwhelming unit growth due to PE-backed competitors 

• VIOC has the best mousetrap and should be able to build units more efficiently than competitors, however there is risk that industry-wide ROICs might suffer if there is an over-supply as we saw in the car wash market with the rise of PE-backed entrants
• We take comfort in our TAM math as a mitigant for oversaturation 

• EV Growth

• VIOC is piloting EV programs in several locations and early results are promising 
  • Our checks indicate 15 – 20% fewer visits, but 20% higher ticket, so limited net impact

• Easy to hedge given VIOC is overindexed to older vehicles in the car parc. An EV loser basket is one potential options, but we prefer idiosyncratic short exposure

• Limited impact to next 5 year #s

Appendix 1: Overview of Services

Appendix 2: Average Automobile Age by Type 

Note: Should any of the images / analyses not load, please reach out to spectercapital21@gmail.com for a fully-formatted memo. We would like to keep any discussion on the idea board though. 

Catalyst

1. Earnings Beat

2. Unit Growth Accel