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Takeaway: Solid candidate for Best Idea Long. At a minimum, a long into next week’s investor day.

Valvoline (VVV) was spun out of Ashland in Sept 2016.  Since then the company has been covered by chemicals analysts.  However, within VVV is two different businesses, and neither of which should be covered as, or valued like, a chemicals company.

  • One business (68% of revenue and 54% of EBIT) is a consumer engine oil brand with a premium brand positioning, with solid margins, in a low to no growth and highly competitive industry, that sells into US and international retail channels of auto parts stores and mass merchandisers, as well as installer service centers.  This is the two segments of Core North America and International of selling mainly Valvoline branded engine oil.
  • The other business is a consumer service/retail store, with high margins and comping high single digits, in a moderately growing industry that is consolidating, with relatively weak competition, and big market share opportunity with a successful franchising model.  This is Valvoline Instant Oil Change (VIOC) the main entity of VVV’s “Quick Lubes” segment. (32% of revenue and 46% of EBIT)

The company’s stock price has been dragged down by weak performance in Core North America as the DIY channel is seeing an abnormally promotional environment which is hurting volumes and margins.  Meanwhile the VIOC business continues to put up great performance, including accelerating comps in this last quarter to +10.8%.

If we think about these as separate companies…

One (NA and INTL) should be valued like moderately struggling CPG company.  Probably 9-11x EBITDA. 
The other (VIOC) should be trading like a high return, franchised/asset light, consumer store model with lots of growth runway.  That’s anywhere from 15-25x EBITDA.

Yet the entire company is trading at just 9.7x EBITDA today.  With where we think those 2 businesses will be in EBITDA in a year, and what we think are fair multiples (10x and 17x) we can argue 40-50% upside from current levels.  If Valvoline Instant Oil Change does what we think it can over the long term in terms of market share and profitability, it could easily double EBITDA and potentially command a multiple 2x the market is applying today.  That equates to over 110% upside for VVV equity over a tail duration.

Simply saying that the market is valuing this company wrong is not a catalyst, which is why this stock is not a Best Idea Long yet.  But the investor event on Thursday may very well be the catalyst to start VVV on the path of separating the two businesses. At a minimum the reporting, disclosure, and commentary can be revised to better outline the opportunity for big, long term, profitable growth out of VIOC.


VIOC Opportunity

  • Valvoline has likely the best retail/consumer concept and growth story you’ve never heard of.
  • Valvoline Instant Oil Change is taking a proven, quality service and marketing process approach to an already good industry of oil changes and basic auto services that often operates under subpar processes and business practices.
  • The industry is ~$6bn growing low to mid-single digits.  That number is for quick service oil changes stores, which doesn’t include the portion of the market consumed by dealers and general service garages, which is large.
  • There are ~7000 stores, Jiffy Lube has ~2000, VIOC has ~1300, Pennzoil Oil Change ~700, then many smaller/regional players, and mom and pops.  We think VIOC could get to 2200+ stores (including acquisitions).
  • VIOC has Mid 20s 4-wall margins, HSD to Low DD comps the last 15Qs, and rapid store growth both organic and acquired. A rarity in any retail/DIFM operation.
  • The competition is relatively weak in this industry.  The number 1 player is Jiffy Lube, it is 100% franchised (VIOC is 36% company owned) and is owned by Shell, which has much bigger businesses to worry about.  Also in our opinion Jiffy Lube has weaker processes for training and marketing, meaning an inferior and less consistent customer experience and monetization.  Mom and pops are not focused on process improvement and maximizing sales and profits, as many are not even open 7 days a week, sometimes not even 6.
  • We think there is also secular tailwind as changes in perception of time are driving new customers away from DIY each year towards services like VIOC.  About 20% of people in the US do oil changes themselves today.


Separating the Businesses?

  • The company so far has been resistant to separating the businesses.  There are some internal accounting elements that make the quick lubes margin inflated.  The owned stores of the segment gets to “buy” oil at cost. So that is about 500bps of margin that should be EBIT within Core NA (lower multiple on that EBIT).  We are factoring this in on our upside calculation.
  • The argument that makes the most sense for keeping the businesses together is that FCF generated from Core helps fund accelerated store acquisitions at VIOC.  That makes sense, but VIOC is rapidly becoming a large part of EBITDA, and likely eclipses Core NA within a year.  Plus, if cash is truly needed for VIOC to drive its growth trajectory, investors (debt or equity) would likely be happy to put money behind that story.


Timing

  • We think Core NA is likely to improve on the margin in upcoming quarters, as we are starting to hit the easy comparisons, and the company is taking actions to stave off share loss.
  • We have no reason to think VVV will do anything but continue its stellar performance in upcoming quarters.
  • Oil prices do impact the business, as base oil is the main input cost on COGS. We’re still ironing out how the price drop of last fall, and subsequent rally this year could impact fundamentals near term.
  • What the company says on goals and strategy at the investor day will be important as to whether this gets elevated to a best idea long.  If a business separation is announced, it’s instantly a best idea – and might become one anyway if we gain conviction that shareholder support will build to split the company.


VVV | A Long Into The Investor Day - 5 9 2019 VVV idea list