Q3 2022 Valvoline Inc Earnings Call
We're all corporate margins by roughly 400 basis points, while demonstrating a faster growth and high returns profile.
Beginning with our guidance of 30% to 32% retail services segment margin, we must allocate approximately 50% of our legacy corporate costs to derive our comparable corporate EBITDA margin.
The synergies from the transaction, mainly incremental standalone and supply agreement costs reduced margins by roughly 300 to 400 basis points to generate our 23% to 26% margin targets.
The brand used for product purposes as reflected in the transaction consideration and so no brand licensing fees are involved going forward.
Despite separation dis synergies, we're confident in our long term growth margin profile and cash flow generation.
Regarding sales growth, we've outperformed historically driven by same store sales and store additions. So there's room for upside in our outlook as well.
Pro forma 2022, EBITDA margins are forecasted to be slightly below our long term expectations, primarily due to the price cost lag from the extreme raw material inflation that we've seen this year.
The improved valvoline corporate margin profile, coupled with optimized capital structure and capital allocation is projected to drive 20% or more of EPS growth annually.
Let's review, our Q3 results starting on slide eight.
Our results in Q3 show that the demand profile for Valvoline products and traveling services remains robust with both businesses continuing to capture market share.
While we are experiencing temporary dilutive effects on profit margins due to higher cost and price pass through impacts the strength of our topline growth highlights the non discretionary nature of our preventive maintenance business and positions us well for margin expansion when the current inflationary cycle eases.
Let's turn to the next slide to look at retail services results for the quarter.
Our retail services segment continues to generate strong topline growth with Q3 sales increasing 16%.
System wide store sales also increased 16% driven by a nearly 10% same store sales growth and an 8% increase in units.
On a two year stack basis, our same store sales in the quarter grew in excess of 50% and for the year, we expect growth in excess of 30%.
At the end of fiscal 'twenty, two we expect to have delivered our 16th consecutive year of same store sales growth.
We have a three pronged approach to expanding our retail footprint.
<unk> company stores acquisitions, and working with our franchisees on their store development.
We anticipate adding 140 to 160 units this.
This fiscal year with.
With a strong franchise contribution as they continued to invest in growth.
Sure.
Turning to slide 10, Let's review our recent margin performance in the context of our segment strategies, our segment targets and by comparing year over year and sequential performance.
In Q3 last year EBITDA margins ran well ahead of our long term targets driven by high store utilization levels.
We were understaffed in our stores, but seen a significant rebound in transactions, leading to roughly 300 basis points above the midpoint of our target range.
As we said during our earnings call last quarter, our segment EBITDA margins in Q2 were below our long term targets due to product and labor inflation as well as labor investments, we made to improve staffing levels and turnover.
We took pricing actions beginning in early Q3 to improve margin performance.
Those actions were successful and drove a 230 basis point sequential increase in margin rates this quarter.
While improved our Q3 margin was slightly below our long term target driven by continued inflationary pressure as well as the dilutive impact of passing through higher product cost and sales to our franchisees.
Which drove 100 basis points of margin decline year over year.
In Q4, we expect similar margin performance to Q3, however, with continued topline growth, we expect better flow through to profitability, leading to a solid year over year growth in segment EBITDA.
While the macro environment remains challenging we are monitoring potential impacts of higher inflation on consumer behavior and any differences by region.
We do have levers to address any developments, including adapting our digital marketing offers among others.
We remain confident in our targeted segment margin range, given our topline strength, we are well positioned to see or see both improved EBITDA dollar growth and margin expansion as inflationary pressures ease and the margin leverage of our model is demonstrated.
Let's review global products results on the next slide.
Volume growth in global products continues to be impressive with a 9% increase in Q3. These results were generated despite disruptions to the business from geopolitical events and Covid, particularly the lockdowns in China.
With demand strength continuing.
Combined with pricing actions adjusted EBITDA grew 7%.
Unit margins continued their sequential improvement progress in Q3, highlighting the businesses ability to efficiently pass through earlier rounds of raw material cost increases with pricing.
Nonetheless, with raw material costs, continuing to increase we expect impacts to profitability in Q4.
Despite disruptions and higher costs discretionary free cash flow for this segment remains strong and steady.
I will now pass it over to Mary to further discuss our financial results for the quarter.
Thanks Sam.
Our Q3 results are summarized on slide 13.
Strong top line growth was broad based across segments and channels highlighting ongoing robust demand.
Overall sales growth of 21% in the quarter was driven by 15 points of pricing, including pass through of raw material inflation and nearly six points from favorable volume mix.
The growth in adjusted EBITDA was primarily driven by volume mix benefits, partially offset by a modest increase in SG&A due to wage inflation and normalizing levels of travel and advertising.
So let's take a closer look at segment results on the next slide.
Okay.
Dale services growth.
Retail services sales growth of 16% includes same store sales of nearly 10%.
The continued strong performance in the business with ticket growth outpacing transaction growth in the quarter.
EBITDA margin in retail services was down 450 basis points year over year, highlighting the difficult comparison and dilutive impacts from inflation that Sam mentioned earlier.
Margins improved 230 basis points sequentially with the pricing actions, we took while.
While we do not expect significant improvement in Q4 due to ongoing price pass through effects, we remain confident in the long term outlook for margin enhancement.
Sales growth in global products continued to run well ahead of strong volume increases in Q3.
Margins also saw a noticeable sequential improvement.
Both of these highlight our ability to pass through inflationary cost or pricing.
Let's review our updated guidance on the next slide.
We are updating our guidance range for adjusted EBITDA, and now expect $670 million to $680 million on a consolidated basis.
Going into the year, we didn't expect the level of inflation that we've experienced the.
The reduction in guidance for retail services is primarily related to the unfavorable price cost lag from higher raw material costs. Our updated outlook represents a low double digit growth in earnings year over year at the midpoint for retail services, a meaningful increase in a challenging environment.
On adjusted EPS, We now anticipate $2 seven to $2 15 a share.
We are reducing our guidance for free cash flow to 140 to 160 million <unk>.
<unk> raw material inflation is driving a higher working capital investment in our global products business.
Inventory values increase and price pass through leads to higher levels of accounts receivable.
Now as you return to slide 16, I will turn things back over to Sam to wrap up.
Thanks Mary.
As we turn our focus to preparing for the new fiscal year, we are expecting strong profit growth as we move past the impacts of product inflation.
While we've guided to a mid teens EBITDA growth on average given the challenges that we'll be lapping we expect a stronger EBITDA growth rate next year.
We also will be focused on minimizing corporate dis synergies and optimizing SG&A, we look forward to sharing more on our fiscal 'twenty three outlook for the new Valvoline at our year end earnings.
Yeah.
We are bullish on our capabilities and opportunities in automotive aftermarket services.
On our roadmap to drive shareholder value. We remain we remain committed to our successful growth strategy of making vehicle care easy and accessible for our customers.
We will optimize our capital structure and capital allocation policies to supplement the growth in our core business, where we expect to continue to grow market share in non oil change revenue.
With a footprint of nearly 700 stores that currently reaches less than 15% of households.
We have significant opportunities for unit expansion and we will be increasing our emphasis on franchisee growth.
Finally, with a clear.
Focus, we will increase and leverage our scale to prepare for and capture new customer and service opportunities.
We are very excited about the future of retail services and we are pleased that we have found the right strategic partner for global products.
Finally, I'd like to again recognize our teams across Valvoline I am proud of the results we've generated growing the business and delivering outstanding customer service well working through a rigorous separation process.
This gives me great confidence that we are ready for the next step in our transformation.
With that I'll hand, things back to Sean to open the line for Q&A.
Yeah.
Thanks, Sam before.
Before we open the line for Q&A I'd like to remind everyone to limit your questions to one and maybe a couple of follow ups. So that we can get to everyone on the line.
With that Sam Please open the line.
Thank you Shawn we will now begin the Q&A session, if you'd like to ask a question. Please press star one on your telephone keypad if for any reason you'd like to remove that question. Please press star two.
As a reminder, if you are using a speaker phone. Please remember to pick up your handset before asking your question.
Our first question comes from the line of Simeon Gutman with Morgan Stanley .
Your line is open.
Hey, guys. This is Michael Kessler on for Simeon Thanks for taking my questions.
First I wanted to ask about.
Retail services EBITDA margins.
So a little bit below.
The longer term targets that you previously outlined and on a pro forma basis as I have outlined to US is the gap is it just primarily due to the raw material cost inflation and the lag in passing the franchisees I guess is there anything else that would explain the gap.
And then if we're thinking about next year.
We get a more stabilized pricing backdrop should we expect that the margin should come back into on like on a pro forma basis of 23% to 26% range.
Yes, so first of all you're correct in that our our margins going into it from in Q3 and going into Q4. They are impacted by those higher prices that we're passing through to franchisees so impacting our percent margins.
We did note earlier in the year in Q2.
We had a margin decline that we took appropriate pricing actions.
And our oil change services and our additional services and those helped us recover margin in in Q3. So when we look at our current pricing in the stores.
We think we're where we need to be in terms of our margins for both oil changes and services and so now we're talking about that percent margin being.
Got depressed by that that.
That.
That pricing.
<unk> to our franchisees primarily.
Okay. That's helpful and maybe one follow up on that and then just wanted to separate question.
On the the longer term range, 23% to 26%.
Can you talk about I guess the drivers we can kind of see that.
There's a little bit of probably uncertainty around.
In nature of corporate costs, and a separation what the exact impact of the supply agreement looks like et cetera, but the gap between 23 and 26 can you talk about just puts and takes and why you might end up at the lower end versus the higher end and when we say long term when you guys say long term.
Is 2006 kind of a good upper bound to think about or if we're thinking out several years there could be room for further expansion.
Yes.
<unk>.
Yes, we're thinking about like the say 23 to 26 period, when we talk that that both near term and long term and so I would expect us to be probably closer to the 23% range as we begin this next period.
We do have some more work to do as we prepare for fiscal 'twenty three on the dis synergies in the corporate cost and making sure that we've got our cost structure optimized and so we will shed some more light on that when we do our.
Q4 earnings call and guidance for 'twenty, three but our model has significant leverage in it and so we've proven this overtime as we grow <unk>.
Same store sales.
And continue to grow at a healthy rate, it's going to improve our margins over time and so we would expect margin improvement from 23 through 26, each year as we continue to drive performance and we remain very confident in our ability to continue to capture market share.
While improving performance in the stores with thought with ticket non oil change revenue.
Great. Okay. Thank you and sorry, maybe one last follow up for me and then I'll sure.
I'll close just on the same store sales algo for retail services I know the total total growth came down a little bit versus your prior.
Your prior guide so if you can just talk a little bit about about that and then just thinking about the same store sales build in.
In the out years I'm, just kind of on a normalized basis is there any any changes we should be thinking about and just to build their ticket versus traffic.
Anything I guess needed to note given that <unk> had three years of I would say pretty strong compounded growth. Thank you.
No doubt the last few years have been incredibly strong with same store sales performance and.
I don't know that we will continue in the double digit range, but we'll always be striving for that we still have plenty of opportunity, but we will work on our guidance for fiscal 'twenty, three and I believe it's going to continue to be strong because we're seeing.
Good solid opportunities in both growing market share, winning new customers, retaining those customers and selling them. The additional services, providing those services that they're that they're needed.
And seen ticket performance too.
So the algorithm doesn't change we would expect that transactions will be a healthy component of our same store sales growth moving forward.
But we also see the ticket performance driven by premium innovation of oil changes.
Pricing leverage in and.
Selling the.
And providing those additional services for preventive maintenance being key when we look at our performance. This past quarter, both transaction and ticket contributed to that same store sales growth of roughly 10%.
About a third of it was driven by transactions two thirds by ticket performance.
But.
I think it will be relatively balanced.
Moving forward.
With that.
Transaction growth in the.
Contributing.
Close to anywhere from a third to half of the overall same store sales performance and the balance being ticket.
And Sam if I could just add on to that a little bit.
I do think if you think about.
Our long term range for same store sales growth of 6% to 8% and unit growth of 6% to 8% over time, there certainly is some upside opportunity but.
We're guiding at the lower end.
To make certain that we.
We're able to.
Certainly provide a reasonable level of guidance on both of those going forward and then in addition to that Michael you mentioned on the 20.
23 margin rates I do think we're going to still see some dilution effect of the price cost through the franchisees, we have seen additional raw material cost increases.
Here in the last several weeks.
And that price pass through is continuing to the franchisees. So I think some of that dilution is going to continue and you might see the 'twenty three numbers there'll be a little bit light relative to the low end of the guidance when we come out with our final guidance for for fiscal.
Fiscal 'twenty, three primarily driven by the dilution of that product cost pass through.
Thank you for your question Mr. Kessler.
The next question comes from the line of Mike Harrison with Seaport Research Mike Your line is open.
We're we're only doing even in the DIY market.
5% of all the oil changes out there and we talked about the opportunity to increase our store count that's one aspect, but the other aspect is the fact that.
There's a real shortage of mechanics at dealerships.
<unk>.
Tire and repair and that creates a real problem for them to even be able to do preventive maintenance as they focus on repair and so I think the opportunity to see more preventive maintenance come our way is really substantial and so big picture is that despite any macro environment challenges the opportunity for valvoline.
To leverage our model for <unk>.
Consistent and long term growth is really substantial and we look forward to sharing more about that in the future.
Alright sounds good thanks, very much for the color.
Sure.
Thank you Mr. Harrison.
As a reminder to ask a question. It is star one on your telephone keypad again that is star then the number one.
Our next question comes from the line of Jason English with Goldman Sachs Jason.
Hey, good morning folks thanks for slipping me in good morning.
Couple of quick questions, Sam you mentioned the.
The leverage that exists in the model to help drive margins up over time.
We haven't historically seen that play out in your P&L and I think the reason is because post your separation from Ashland, you were putting a lot of new stores in the ground and they were mixing down margins over time.
Hey is that understanding correct and b at what point will we get to this inflection where the number of new stores you are putting in the ground is negated by the number of old stores hitting their sweet spot and we can actually start to see the leverage youre talking about flow through to the aggregate P&L.
Right.
We have tried to share in the past and we have shared in the past what that leverage looks like in our mature stores and so taking up the new store impact and so as we've shared the mature store.
Margin leverage we've seen it grow roughly $5 to 600 basis points in the last five year period, and so I think we need to continue to get that in front of investors. So they appreciate the leverage in the model now it has been impacted by the.
The accelerated new store growth and so.
Thats muted the leverage that you see at the bottom line. In addition to the factors that we've called out from the volatility of this past year I mean, thats been the number one impact.
Offsetting leverage in the model has been the rapid inflation of this past year. So I think again, we will.
Start to see improvement next year, but as we forecast out that 23 through 26 period.
We will see a steady progression of <unk>.
Improving leverage.
Even at.
This higher level of store growth that we're seeing that we will have equilibrium there and we will see then the progression of the model flowing through with leverage to the bottom line.
We also talked about store growth and wanting we see a big opportunity for accelerated store growth and we've come a long way.
Over the last five years to ramp up to this 140 to 160 range for this year and what we delivered last year too.
I think we could do even better than that in the future, but leaning even more heavily on our franchise system.
We've got some strong franchisees.
We are interested in strengthening our franchise.
Partners for continued growth and even faster growth than what they are doing this year is a nice step up in performance. This year from previous years, but I think we can do even better and then that also helps our <unk>.
Leverage in the <unk>.
Model.
Yes understood.
Coming back on this cost price lag.
Jeez, we've had lots of conversations in the past you've always characterized the retail services business.
As reasonably insulated from this because you can always see the costs coming right you see the base oil prices going into global products. You know what the cost is going to be to you reasonably well in advance and you have got what was historically described as almost an immediate pass through escalator clause with your franchisees and the ability for.
Are you, giving a line of sight to rapidly change in store. So there would be no lag here. We are this year and there is a substantial lag that's not just impacting ratios and I get numerator denominator impact.
Packaging unit economics, and Penny profit so what's what was wrong about the prior description why is it broken down and why is this business proving to be more inflation sensitive than we all expected.
Well im not about making excuses and I won't go back on the description of this business being quite insulated from price cost lag effects that we see on the global product side. Nonetheless, like that the level of increases that we've had in product costs have created a bit of a.
Negative impact and.
On the labor side too.
We admitted our Q2 performance was being.
A little bit behind where we needed to be and adjusting prices and we corrected for that in Q3. So.
Little little bit of challenge, there, where I think we underperformed where we could be.
We're talking about now is more on the like when we look at the.
The EBITDA margin percentage being negatively impacted by the price pass through it's not a profit impact as we pass through prices.
Our franchisees because we adjust prices on a quarterly basis.
Net profit impact is not that significant.
If anything we could get a 45 day lag.
But on a percent basis it has been.
A factor.
For our margins so don't misinterpret, what we're saying about the model and the strength of the model.
And certainly.
As we project forward and our ability to manage I would say more typical.
Inflationary in fact impacts.
Model is again quite resilient.
I don't know Barry do you have anything else to add to that.
No I mean, I think you said it well.
I think Jason the biggest challenge we've had has been the speed and size of the types of increases that we've seen in the underlying product cost.
In the face.
Initially.
Post COVID-19 impact on refining capacity and more recently the Russian Ukrainian conflict.
That has caused.
Base oil.
<unk> two.
B at really all time highs.
So.
The impact on the unit margins in panic and Penny profit relative to what we had planned for the year.
Higher.
And we have taken pricing action and overtime, we expect that to moderate in fact, we really think that will benefit over time.
As we see those costs moderate and potentially provide structural long term improvement to our margin.
The business continues to have pricing power, but we do operate in a competitive environment. So.
I'm actually feel good about the long term opportunity for the business when we get past that.
Rather unusual.
Slight inflationary environment.
Understood. Thanks for your time.
Alright.
Thank you Mr. English.
That concludes our Q&A session for today, so I'd like to hand, the call back to Sam Mitchell for any final remarks.
Well that's it for today.
We obviously are focused on now the transformation of the company and completing the execution of the sale of global products and preparing retail services for fiscal 'twenty three.
We have managed through some significant challenges this year.
The business is in excellent shape, and we look forward to an exciting future as a pure play automotive aftermarket services business.
Thank you.
That concludes.
Valvoline third quarter 2022 earnings conference call and webcast. Thank you all for your participation you may now disconnect your lines.
Okay.
Sure.