Monro, Inc. (MNRO) Earnings Call Transcript

Good afternoon, everybody. I am Michael Lasser, the hardline, broadline and food retail analyst from UBS. And I could not be more excited to have the team from Monro with us today. To my immediate left is Brian D'Ambrosia, who's become a regular staple at the UBS Consumer Conference. I think this is my -- maybe your fifth or sixth time here. So we are going to start handing out medals and Brian is going to be leading for that count. So we're greatly appreciative of that. He is the company's Chief Financial Officer. And next to him is Felix Veksler who runs the Investor Relations effort. Monro is a super interesting company because it operates in part because it operates in a very interesting sector of our economy, which is the auto services sector.

So Brian, where I want to start, I want to set the table is, give us an overview of the market that Monro serves and how does Monro fit into the marketplace?

Yes, absolutely. Thank you, first of all, for having me back, and thanks for everyone's time this afternoon. Monro operates in the auto services aftermarket. The auto after -- the auto services aftermarket inclusive of tires is about almost a $400 million -- $400 billion category. That is comprised of just over $300 billion in the Do-It-For-Me segment. So Do-It-For-Me is about 75% of the auto services entire aftermarket. DIY is about $100 billion or 25% of that. Through the auto services aftermarket, the DIFM side of it, there's about little over 100,000 locations, independent -- independently operated locations that serve that car park, the car park being about 300 million vehicles. One of the drivers of the DIFM category as well as growth in the DIFM category is related to vehicle complexity. So vehicles have been complex for a while. They continue to get more complex. And those lend themselves for service and maintenance, needing a professional mechanic to perform those maintenance services and keep you on the road safely. I don't think that's going to change. I think that, that shift has been made, and it continues with every new model year that comes out to become more and more difficult to work on your own vehicle. Important about the auto aftermarket is the car park itself. Car park itself is, like I said, about 300 million vehicles. It is -- the drivers of Monro and demand in the Do-It-For-Me category really come down to the number of vehicles on the road, which is large and growing. The age of those vehicles, which is up to over 12 years, up 2 years since I've been in the industry just over 10 years ago, so it continues to age pretty consistently. And then the third piece is really how many miles are being driven on those vehicles? And we are back to pre-pandemic levels in terms of miles driven. We're probably foregone about 4 years of growth in vehicle miles traveled over the last 4 years. The constitution of those vehicle miles traveled is a little different from commuter miles and things like that. And also, if you take the higher number of cars on the road and divide it into the vehicle miles traveled, you've seen a little bit less travel per vehicle on the road. So those dynamics are important as we think about long-term trends in the industry, which are very supportive of the auto aftermarket and the services the auto aftermarket provides. I would say that, for Monro, we are one of the top -- in terms of top locations, we have 1,300 locations in 32 states. We -- that puts us in top 5 of the largest providers in the country. Just to give you a sense, the top 15 of the -- or the top 10 have about 15% market share. So there's a significant amount of fragmentation in the service providers. You can actually own only about 10 stores and be a top 100 tire dealer in the U.S. So it's a lot of fragmentation and opportunity for consolidation in the industry. I would say, as it relates to kind of the short term, right now, I think the biggest thing that is putting some pressure on the auto aftermarket, particularly in the tire category. It's -- the highest -- one of the highest ticket services you can have in our list of services, which include oil change, brakes, tires, alignment. But tires are the most expensive, and they're the most kind of economically sensitive. And our low to middle income consumer is we're seeing them defer and trade down at this particular time as they're looking for basically not value, but really just a price point in a lot of cases. There's a lot of difference in behavior as you move up and down the household income chain. But for most of our consumers, we're seeing that a lower-value tire has become a real option and maybe their only option. So we try to support them with secondary financing and other things that can help them to really keep their car safe and ultimately put the right vehicle, great tires on the vehicle.

Man. I could unpack that for days. So there's a lot to get into. Number one, what type of customer in general tends to gravitate to a Monro versus going to the dealers? So presumably, is a lower income consumer who's a bit more value conscious. And then within that, you're seeing softer trends on -- within the even lower end of this demographic?

Yes, that's correct. So really, the decision to go to the dealer versus the aftermarket is driven by the vehicle and the age of vehicle. And when you say age, it's almost age/value because rational [ like or not ] behavior is kind of as the value of the asset the you own goes down, the amount you're willing to spend to maintain it also goes down. And so where that then causes the consumer to flip from the dealership to the aftermarket is the -- aftermarket is a value is really delivering value versus the dealer who is typically delivering a little bit more experience for -- meaning the experience within the dealership. But also you're making a little bit willing to make more of an investment and pay a little bit higher because you are investing in a newer vehicle. And the reason why we're able in the aftermarket to offer cost advantages and price advantages to the consumer, is because our technicians really perform that limited amount of maintenance services, oil brakes, tires, alignment. They're not doing a tremendous amount of heavy engine repair, transmission work. All of that is really left for the dealer that factory-certified, factory-trained technician, who needs to do everything from replace a wiper blade to rebuild a head gasket or put a new head gasket on. So I think that -- we just have a different labor model and we also can use aftermarket parts and aftermarket tires and that allows us to have a value offering when it comes to materials as well. So as the consumer trades starts to age out in their vehicle, they move from typically a customer of the dealer to the customer of the aftermarket. And then to your point, within the aftermarket, we're starting to see pressure on that consumer as well. who is looking at their vehicle. Typically, when you see consumer pressure, the first "trade down " is from buying a new car to maintaining the one that's in your driveway. And the second trade down comes from, okay, maintaining the one in my driveway is expensive as well. I need to trade down and be a little bit more value oriented there. And that's where we've seen some of the trade down and some of the deferral in the tire category in particular.

I've been covering this industry, studying it for 20 years. You just put it in some terms that are new and fresh, thank you. With -- so you just provided a little bit of context for what was happening in 2023, the consumer was under pressure. Car counts for Monro, I think were down 8% in 3Q, down 4%. Is that a sign that the consumer has been deferring some maintenance? Is it more so a reflection of some of the weakness in the tire category where you don't do tires, you may not do alignment? How do you diagnose some of those dynamics?

Yes, it's a great question. If you look at our Q3 in particular, that you referenced, our overall comps were down 6% in the quarter, but when you look at tires being down 9% and then our break and service category is down 3%, down 1%, much healthier than the overall comp and certainly much healthier than the tire category. So what that shows us is we still have really good organic demand for brakes and services, meaning the people that are -- that are coming to our shops are coming in for those services still. Why they're still slightly negative as there is a kind of a halo effect or negative halo in this case of the tire category because we do sell brakes and service off of tire visits. So when you have a tire customer coming in, who's buying fewer tires or trading down into a more value-oriented tire, their propensity to spend and add on to other categories goes down. So I think that that's where some of the negative weakness in those categories has come from, but the actual brakes and service as a visit as that's the reason the guest is coming in, we're still seeing very good trends in our business. That all kind of leads me to conclude that it really is this overarching weakness in tires which I'll just emphasize is not specific to Monro. This is a industry kind of air pocket that we're in. It really is a -- consumer is sensitive to price, the category is a high-priced category, and we're seeing the dynamics I explained earlier.

In-- from October through the end of the year, comps were down around 6%. There was some encouraging signs in January where trends improve. What do you think drove that improvement? And is that a sign that the industry is now starting to normalize and stabilize or, hey, it might have been just one isolated data point and still have a guarded view from here?

Yes. I think the data from the industry is pretty clear. There was softness in the early part of January. There was some weather-related tailwinds related to the 3 named storms that came across the country and pretty quick order and delivered a lot of winter weather to geographies that hadn't seen winter yet, that created definitely a stimulus for the industry is when you have tires that need replacement, there's nothing that can make you aware of that, like slick conditions. So we saw an immediate, as you would expect, improvement in tire sales as an industry. I wish that was more durable, but definitely post weather, the industry has reverted and still feels similar pressure to before the weather. So I think that ultimately, what we expect and as what we think is that the nondiscretionary nature of tires can be deferred over short periods of time, even traded down over short periods of time. But over longer periods of time, mix tends to normalize to the appropriate fitments on vehicles, meaning that certain vehicles, even though you can buy a lower-cost tire or lower price value tire on them, you shouldn't -- so that tends to normalize over time as well as tire volumes tend to normalize over time because of the lack of permanent deferrability of that purchase. So it's one of the reasons why the auto aftermarket is such an attractive investment is because of that ultimate nondiscretionary nature of it.

And with tires tend to stabilize over time, I've got one of those EVs and my tires go so quick. From what I understand what someone tells me because I am what they call a not a very sophisticated auto person. I just pretend like I am. It's either because of the torque or the weight and that means that you're running through your tires a little bit faster than with the conventional motor vehicle. So a, is that right? And isn't that a good news story for the market that you serve over the long term?

Absolutely. So first of all, I'm going to add you to my informal survey that I'm [indiscernible].

It's not how I drive. I don't drive that fast...

No. I've talked to plenty of EV drivers, Rideshare and the like, and they all -- I always ask how are the tires holding up, make the same comment. If I feather it and maybe, I can get this much out of it, if I drive it like I want to, it's less. And both of those numbers are below what you would expect given the range of a tire on ICE vehicle.

But -- Meaning the time that you have those tires is lower than...

It is, it is.

And [indiscernible] with this on Honda accord.

That's right. That's right. And so what we've seen is that the weight and the torque are part of it. And that does bode well for us because as we look at the current technology on tires, which is not -- hasn't dramatically changed in terms of range quality. If you want a good ride, you're going to have softer tires. If you want long life, you're going to have a harder ride. And so there's a trade-off. There's a give and take over, over a range and comfort and performance. That technology has not changed that at all. So the EV is going to continue to likely burn up tires a little bit more. That creates tires as a high-ticket item, but a little bit more of a frequency item, which I think is just another way that we see the 15% or so of oil that we have that may be at risk in an EV world, kind of that gap closing through tires and other categories that we'll introduce to replace that. But ultimately, it's a long -- I think we think a long move to get to that point, given the amount of installed base of combustion engines in the aftermarket. I will say, though, is a good example of the fact that we are seeing EV's already in our base and doing all the needed work on them. I often hear that EV owners won't bring it to the aftermarket. They'll go to the only the dealer. Well, I was in Rally last week at one of our shops that does our normal mix of business. And we had 3 Teslas in there, one getting a state inspection, one getting new tires and one getting brakes. It's a pretty good cross-section of our services. And you can see that in a lot of -- a lot of markets that have EV penetration, you'll see that in our base.

My teammate Henry Carr has done some work showing that by 2030, 5% of the vehicle population will be EVs, but it seems like the benefit that Monro can get could be even greater than that just because it is expensive to replace tires, especially through the OE channel.

That's right. We look at it is definitely a net opportunity for us. We're planning for that in that way.

Speaking of planning, how are you thinking about the next couple of quarters from a ticket and traffic? I know you haven't provided formal guidance, so I'm not putting you on the spot from that perspective. But just conceptually speaking, it's been a super interesting time for the auto services business because there's so much inflation that's been passed through on the surface, how would you expect the dynamic to unfold for the sector?

Yes, absolutely. I think that when you look at auto services, particularly the services that we provide, there -- we've said it publicly before that we probably were taking mid- to high single digits at the peak of inflation, but only passing on kind of low to mid-single digits. And part of that was, as you continue to pass cost on to the consumer, you saw the deferral and the trade down, right? So you had to -- really, I think there was a point where the industry was very rational and decided to take and make some investments in price versus taking price and passing down to the consumer. So I would just say that because ticket has not been and inflation has not been as big of a supporter of our top line as maybe other parts of the aftermarket, it has been and who's taken a little bit more price. That being said, we know that to grow going forward, we need a balanced mix of traffic and ticket. And we're aligning all of our internal initiatives, whether it's the launch of our digital courtesy inspection, which is designed to deliver and build a better way to sell in-store and identify needed work for the guests and present that work to build ticket. Or it's the way we have positioned our categories from a price and offering standpoint to be able to make sure that we're relevant and competitive to be able to attract traffic. Both of those things are -- we feel really well positioned going into FY '25. And ultimately, how much of all of that work and the benefit we get to see in absolute terms, I think it's going to be in a large way, dependent on how quickly some of these challenges in the tire category resolve themselves?

I want to get to that in a sec. But how does the digital inspection -- how does that work for those who are a little less familiar with the story?

Yes. So right now, not even right now because we only have 200 stores left to implement this. And so if you would say, 6 months ago, you go into one of our stores and our technician would perform a courtesy, 32-point inspection on your vehicle. If you came in for any service, you get that as a value add. And -- but it will be done in paper form. So the first problem with paper form is as a multiunit manager, like a district manager and regional Vice President, on any given day, they wouldn't know that, that process is happening in store, right? There's no way to check, but trust, but verify. So now that we've got it in a tablet, which is a -- we're using typical industry-level -- commercial-grade tablets, they are doing that same checklist on a tablet. In addition, they have the ability to take pictures, make notes. And when they hand it to the gas, it doesn't have dirty fingerprints all over it and chicken scratch from a technician...

There's nothing wrong with the chicken scratch by the way...

But you'd like the guest to understand the numbers that they're seeing. So we -- so this really presents a much more, first of all, benefit to the guests in terms of much more professional presentation. It builds a lot of trust with the guests because it's a low trust industry where you have a knowledge imbalance, the technician and the store manager know a lot more about cars traditionally than the customer and a lot of our customers, not all of them. And with that knowledge imbalance creates either defensiveness or lack of trust. And so by showing pictures showing industry data on there because it's all gone to industry -- all gone to industry guidance, we can explain to the guests what their current leads are and what their future needs might be. But the most important thing is that we're making sure that, that is done on every single vehicle. So we have that data. We also have the data to be able to say, how well was it done? We can see -- we know that if x number of vehicles out of 10 require a certain service, how well is that tech identifying approximately that number of vehicles? If he's never identifying that on a vehicle, obviously, that is impossible, given we know that x number of vehicles on the road require that service or vice versa, if he's over identifying, we have a production opportunity. We also can see what was found and then what ultimately our store manager was able to sell. So we can see how effective the store manager is at taking what was found on the vehicle and being able to communicate to the guest and translate that into an additional service on that ticket. And then we can also identify how many times that was presented, but declined by the guest because then we can move that over into our CRM and market back to the customer for that service in the future, knowing that they declined at that day. So it's -- the visibility created by that one piece of paper turning into a tablet really changes our control over what's arguably our most important ticket driver in the company, which is a digital courtesy inspection.

And what have you seen from the [indiscernible]

While the fact that we've moved it out into 1,100 stores show that we saw success in the early phase as we've rolled it out in about 5 or 6 phases. And in each phase, we've seen what we would expect to see. We would see that based -- versus the control group, we've seen attachment of items that are traditionally sold through inspection. You're not going to sell a lot of oil changes through inspection. But you are going to see more brake sales, more alignments, more batteries. Those are the things that typically kind of show themselves in a traditional individual inspection. And because of that, we really feel like it's an opportunity for us to support our service category through that process. And at the very least, if they're not selling more that day, we've created a better relationship with the guest after they leave our store.

Meanwhile, Felix has been going to a paper with annual report. So now you can talk about this across your organization. I want to talk about another initiative that Monro has been putting in place, which is managing some of the labor hours within the stores. What has been prompting this, and where does it stand today?

Yes. We've -- I would say the most important thing, I would say, first of all, before we talk about the managing of the hours is that we're staffed for growth. So I mentioned we were down 6 in Q3. But at the same time, if we were up to, which is obviously aspirational when you're running down 6, we would have had very little incremental labor investment. So we feel like that we have a significant amount of leverage on our pool originally at post-COVID, after we had to run a lot of zero-dollar schedules and furlough some employees to react to the decrease in vehicle miles traveled. It took a while for us to get back. And our whole premise was that we had demand that was outsized above our capacity. We really did a good job of hiring into and building that capacity of technicians to meet the demand. We have seen some softening in that demand as we've been talking about. But the good news is we haven't had to really downsize our staffing. We really managed that through schedule. And that's getting the teammates scheduled appropriately so that we're not running unproductive overtime. We're not running a lot of unproductive time at any point during the work week. We're scheduling the right days and the right day parts. And we're moving labor around to the stores that have the most need for us. So I think we've done a really good job there, which allowed us despite being down 6% to leverage the previous year and expand labor margins by 40 basis points. So I think what that means for us is if that down 6% was higher, let's say, even the up 2 I mentioned, you see significant leverage. That's another 100 basis points of leverage because we will not be adding costs back in as fast as the sales will leverage.

Got you. And what is the market for tech right now? Is it -- this has been a challenge for the whole industry for the last several years? Where does it stand right now?

Yes, I would say it's been a challenge for the industry for a decade. And I think it was -- these are highly -- when you look at the technicians, the highly trained technicians, they're in high demand. There's a shortage that started before COVID related to the amount coming through trade schools. And it's something that we've, I think, as an organization, done a really good job of replenishing and replacing a lot of the technicians that we were forced to separate with during COVID. That being said, it's highly competitive. But I think our technician turnover is at a place where we can really feel good about the growth opportunities that it provides because a stable technician base is important. Where we've seen higher levels of turnover is in our entry-level technicians, which you would expect. They are technicians that are less wed to the industry. They're more -- they could see themselves going to either being -- going to target, going into other parts of retail. But our job is to bring them in, try to invest in them and put them on a career path and develop our technicians of the future. It doesn't always work. It's more of a turnover in those entry-level technicians. But at the same time, it's not as kind of penalizing as when you lose one of those higher-level tech.

Maybe as we need less sell-side research analysts, we could repurpose some of those to be tech. How are you thinking about wage pressure associated with the technician for the -- across the market? And if you could put that in the context, and then what's the ability to pass that along in terms of -- in retail prices?

Yes, that's a great question. We've seen that mid-to high single-digit number I talked about that we saw an inflation earlier. That included labor and materials. Labor was leading that higher. Now probably from a technician wage perspective, we're seeing mid-single digits, low mid-single digits of wage increases. So that inflationary pressure is still there. And that's where we've done a really good job of what we call walking back the rate, meaning attacking time and a half -- unproductive time and half, unproductive premium pay, unproductive time in general. It's helped us to manage that rate down to something that's more productive and below, allowed us to be in the 4% to 5% inflation trend to something lower. Passing price on to the consumer, I think we feel good where we're priced now, and we're really I think keeping our eye on competitive dynamics and making sure that we're priced where we want to be relative to our competition. Going into this inflationary period, we really used it as a way to kind of reset our pricing and get relative in every category to where we want to be from our competitors. And we do that regularly. We scrape all 100 of our DMAs and we look at our primary competitors in every market, and we make sure that our pricing is -- has the right distance that we want between composition.

And what are you seeing on the raw materials -- on the parts front? Is it stable? Or are you still seeing some inflation there? And how is that filtering through?

I would say, stable, yes. We haven't -- I would say, it's not significantly inflationary. It's not deflationary. It's probably stable to disinflationary at this point.

Disinflationary. The industry has always passed along modest increases. Would it be reasonable to expect that, that's the go-forward, very typical type inflationary pressure?