VVV

Publicly traded companies mentioned herein: Advance Auto Parts Inc (AAP), Ashland Global Holdings Inc (ASH), AutoZone Inc (AZO), Boyd Group Services Inc (BYD CN), Copart Inc (CPRT), Driven Brands Holdings Inc (DRVN), Edgewell Personal Care Co (EPC), Energizer Holdings Inc (ENR), IAA Inc (IAA), KAR Auction Services Inc (KAR), Mister Car Wash Inc (MCW), Monro Inc (MNRO), Newell Brands Inc (NWL), O’Reilly Automotive Inc (ORLY), Royal Dutch Shell PLC (RDSA NA), Spectrum Brands Holdings Inc (SPB), Valvoline Inc (VVV), Walmart Inc (WMT)

Highlights

The presenter is long shares of Valvoline Inc (VVV), which was spun out of Ashland (ASH) in 2016. Valvoline consists of two businesses. The first is Retail Services, which is made up of 1,600 quick lube locations (d.b.a. “Valvoline Instant Oil Change” with 700 company owned units and 900 franchised units). They are the No. 2 player in the space behind Jiffy Lube (2,200 locations), which is owned by Royal Dutch Shell (RDSA NA). For FY ‘21, Valvoline’s Retail Services will be slightly more than half the total company’s EBITDA. Valvoline’s second business is Global Products, which is broken down into two segments. The N.A. business mainly consists of sales of Valvoline motor oil products to DIY channels, Walmart (WMT), AutoZone (AZO), and the like. That’s roughly two-thirds of the EBITDA of that segment. International represents the other one-third of EBITDA. That involves sales of lubricants more for industrial and commercial applications like heavy duty trucks.

On Oct. 12, Valvoline management announced plans to separate the two businesses, Retail Services and Global Products, to maximize shareholder value. As of Q4 earnings on Nov. 3, management hasn’t established a timetable for the completion of the separation. Historically, management hadn’t indicated much interest in a restructuring. With Retail Services now more than half of EBITDA, the presenter thinks that factor led management to reconsider. Another factor in the decision may have been valuation uplift on similar businesses. Mister Car Wash (MCW), for example—which is similar in terms of high unit growth, margins, and comps—went public and has received an EBITDA multiple north of 20x on current year numbers. Valvoline traded at an 11x - 12x EBITDA multiple before the announcement of the split, so the valuation discrepancy has become clear and is no longer hypothetical. 

The stock has traded well since the announcement, but the presenter is still bullish on the setup. From a pattern recognition standpoint, he feels that this sets up similar to when IAA Inc (IAA) was spun off from KAR Auction Services Inc (KAR) in 2019. In that situation, IAA had become the major driver of earnings within KAR. IAA’s closest peer, Copart (CPRT), had undergone a good deal of multiple expansion while KAR still traded at a middling multiple that seemed anchored to the smaller wholesale business. Even after that announcement occurred, the stock traded at a meaningful discount to the sum of the parts. Once the separation was final, the valuation gap with Copart closed very quickly.

Valvoline Instant Oil Change is an excellent business. Over the past 5 years, the company has grown units at an 8% CAGR. In that same period, same store sales have CAGR’d at 9%. They have comped positive for 14 straight years, and grown EBITDA at an 18% CAGR. They operate in a large, fragmented category, 40% of which consists of mom-and-pop operators. Valvoline is also competitively advantaged by both their technology and processes which allow for better throughput and speed of service, as well as their brand recognition and advertising scale. All of these factors put them on strong footing for taking market share going forward.

Over time, the presenter sees Valvoline growing to 3,000 units, which would be larger than Jiffy Lube. The unit economics are strong, with cash-on-cash returns for new boxes in the low-30% range. He thinks the Valvoline Retail business deserves to trade in the same vicinity as peers such as MCW and Driven Brands (DRVN). On ’21 EBITDA, MCW trades at 25x and DRVN trades at 21x. Boyd Group (BYD CN) trades in the low-20x range. A similar low-20x EBITDA multiple for the Valvoline Instant Oil Change business seems reasonable versus a bear case of 15x, closer to where Monro (MNRO) or O'Reilly Automotive (ORLY) trade.

For the Global Products division, low- to no-growth consumer staples companies like Energizer Holdings (ENR), Spectrum Brands (SPB), Newell Brands (NWL) trade around 10x EBITDA. That seems like an appropriate upside case as far as valuation for Global Products. Edgewell Personal Care (EPC) might be an example of the worst-in-class consumer staples multiple. That trades at 8x and seemingly would be an appropriate low-end bear case multiple for Global Products.

On a consolidated basis, using the bear case multiples and assuming $10MM - $20MM of incremental public company costs, the stock would end up in the low-$30 range, which represents about 10% downside from here. 

On the bull case, however, the presenter sees 40% upside to $50/share, creating an asymmetric risk/reward scenario.

He expects this separation to take 9 - 12 months to play out.

Regarding the bear case, the presenter acknowledges the concern over EV penetration conceivably putting a lid on potential growth for traditional combustion engine oil change services over the long term. However, he points out that the multiples of peers such as IAA, Copart, Advance Auto Parts (AAP), Monro, O’Reilly and others reflect no embedded fear of disintermediation or secular decline for those businesses. Valuing Valvoline in line with OEM suppliers based on the similar bear case of EV disruption doesn’t make sense to him, as the OEM suppliers trade at lower multiples due to weaker margins, returns on capital, growth, and higher cyclicality. He thinks these factors justify the multiple discrepancy. 

Also, Valvoline benefits in the medium term from new cars entering the car park because they require synthetic oil which has 2x the pricing and 3x the profit dollars per unit. He acknowledges that the newer cars with synthetic oil wouldn’t require oil changes as often, leading to the business declining a couple percent per year, which is more than offset by the increased profit dollars. Lastly, the rate at which EVs are becoming a meaningful percentage of the car park is far enough out as to not disrupt this more near- or medium-term trade.

Another bear point is the concern that much of the Retail business EBITDA will transfer back to Global Products on the separation. Right now, as reported, Retail captures lubricants sold to franchisees while company owned units are booking product COGS at cost. The presenter quantifies that risk to represent a hit to EBITDA in the $75MM - $100MM range, which would knock the valuation by as much as $5 per share. The presenter believes that management is keenly aware of this risk and will therefore build in a favorable supply agreement or transfer of brand IP in a way that preserves the economics for the Retail business upon separation.