VVV (Best Idea Long) reports next Wednesday after the market close. The stock has worked well since we went long on June 1, but the risk reward into this event is definitely not as attractive as last quarter and probably favors the bear side.
- Last quarter we saw a significant sentiment inflection as the core NA business showed some stabilization, and it was the first quarter in the last 6 when the company beat revenue and didn’t have to temper expectations around the North America DIY issues.
- Any weakness in Core NA would most likely mean stock downside is greater than the upside should Core NA be inline and VIOC beat expectations.
- In addition, our call is that to truly unlock the value of VIOC, it needs to be separated from the rest of VVV. We remain confident, given our conversations with investors (majority on the sidelines here), that there would be a strong appetite to own VIOC as a separate public company, meaning it could get a very high multiple in a spin. The problem we see is that since the stock rallied so quickly this summer, interested activists may have struggled to build a position at a desired entry price. That means we may need to see a pullback before the activist spin play can be executed.
This remains a best idea long as the basis for our call, the long term bull case on VIOC, is fully intact, but we’d be prepared for a potential pullback and would be trimming if we held a position.
VIOC
The long term bull case is intact. We still think VIOC will open stores, take significant share and dethrone Jiffy Lube as the share leader in the quick service oil change industry. This quarter the company added 25 stores (11 owned and 14 franchised), right in line with the new ~100 store higher annual open rate guidance. Since Q end VVV has already announced 10 new stores (7 owned and 3 franchised).
We expect VIOC comps to look solid, but there is a good chance of a slowdown given the company is lapping price increases in 4Q of last year that has been a comp tailwind all year. We’re modeling 8.5% comps. A slowdown might be viewed as a negative, though that didn’t appear to be the case last Q.
Core NA/International
Our read from the stores is that Core NA remains highly promotional and prices are low. Our expectation heading into the quarter is that volumes show a similar trend as last quarter as the revenue/cost spread improves given the company took price some increases to adjust for base oil price changes.
Our expectation is similar within international, continuation of trend on volumes (flat YY) and some improvement in the rev/cost spread.
We consider these estimates to be relatively conservative, but given the volatility in the category a miss is certainly possible.
Cummins
VVV has an important partnership with the diesel engine maker Cummins Inc. (10-K excerpts below). Hedgeye Industrials Sector Head Jay Van Sciver is bearish on Cummins. Jay’s call doesn’t concern us as it relates to VVV, but Jay published recently on a new Cummins 10-Q disclosure that could end up being bearish for VVV. The disclosure (excerpt below) cites the company cooperating with government agencies in a review of its emissions testing and concerns that parts of the test may act as "defeat devices". Simply put, the language sounds almost like that of a VW’s diesel gate. We do not know the magnitude of the risk here, or if the agreement with VVV would in anyway be in jeopardy down the road, but it appears to be a risk on the margin we wanted to highlight. It will definitely be a good question for VVV IR on follow up calls after the print.
CMI 10-Q:
“On April 29, 2019, we announced that we were conducting a formal internal review of our emissions certification process and compliance with emissions standards for our pick-up truck applications, following conversations with the EPA and CARB regarding certification of our engines in model year 2019 RAM 2500 and 3500 trucks. This review is being conducted with external advisors to ensure the certification and compliance processes for all of our pick-up truck applications are consistent with our internal policies, engineering standards and applicable laws. In addition, we voluntarily disclosed our formal internal review to our regulators and to other government agencies, the Department of Justice (DOJ) and the SEC, and have been working cooperatively with them to ensure a complete and thorough review. During conversations with the EPA and CARB about the effectiveness of our pick-up truck applications, the regulators raised concerns that certain aspects of our emissions systems may reduce the effectiveness of our emissions control systems and thereby act as defeat devices. As a result, our internal review focuses, in part, on the regulators’ concerns. We are working closely with the regulators to enhance our emission systems to improve the effectiveness of all of our pick-up truck applications and to fully address the regulators’ requirements. ”
VVV 10-K:
“Valvoline conducts a portion of its business through joint ventures. Joint ventures, particularly Valvoline’s existing 50/50 joint ventures with Cummins in India and China, are an important part of its growth strategy internationally.”
“Valvoline has a strategic relationship with Cummins, Inc. (“Cummins”), a leading supplier of engines and related component products, which includes co-branding products for heavy duty consumers and a 50% interest in joint ventures in India, China, and Argentina.”
