Valvoline Inc. (VVV) Earnings Call Transcript

Good morning, ladies and gentlemen. Thank you for attending today's Valvoline Special Investor Call. My name is Chequita. I will be your moderator for today's call. [Operator Instructions] I would now like to pass the conference over to your host, Sean Cornett from Investor Relations. Sean, please go ahead.

Thanks, Chequita. Good morning, and welcome to Valvoline's conference call and webcast. This morning, Valvoline issued a press release announcing that the company has signed a definitive agreement to sell the Global Products business to Aramco. Today's presentation should be viewed in conjunction with that release, a copy of which is available on our Investor Relations website at investors.valvoline.com. The company also filed a Form 8-K with the Securities and Exchange Commission today with information on the transaction. On this morning's call, we have Sam Mitchell, our CEO; and Mary Meixelsperger, our CFO. As shown on Slide 2, any of our remarks today that are not statements of historical fact are forward-looking statements. These forward-looking statements are based on current assumptions as of the date of this presentation and are subject to certain risks and uncertainties that may cause actual results to differ materially from such statements. Valvoline assumes no obligation to update any forward-looking statements unless required by law. In this presentation and in our remarks, we'll be discussing our results on an adjusted non-GAAP basis, unless otherwise noted. Non-GAAP results are adjusted for key items, which are unusual, nonoperational or restructuring in nature. We believe this approach enhances the understanding of our ongoing business. A reconciliation of our adjusted non-GAAP results to amounts reported under GAAP and a discussion of management's use of non-GAAP and key business measures is included in the presentation appendix. The information provided is used by our management and may not be comparable to similar measures used by other companies. Now as we turn to Slide 3, I'd like to turn the call over to Sam.

Thanks, Sean, and thank you, everyone, for joining us this morning. We are excited to announce that we have reached a definitive agreement to sell our Global Products business to Aramco for $2.65 billion in cash. Following our announced intention to separate the businesses last fall, we conducted a robust strategic review process with the support of our advisers. Today, with the conclusion of this process, we are marking a pivotal step in Valvoline's strategic transformation into a pure-play auto aftermarket retail services company. I'd like to highlight the key benefits of this compelling transaction. First, the transaction with Aramco represents an attractive valuation of Global Products, and the net proceeds are expected to be primarily returned to shareholders via share repurchases. Second, the sale of Global Products allows Valvoline to concentrate on the fast-growing Retail Services business. With a sharpened strategic focus and optimized capital structure, we expect to achieve a compound annual EPS growth rate of over 20%. Third, we will continue to invest in the business to capture the significant and increasing demand in the preventive services space. With continued growth in same-store sales and the addition of new locations, we expect to continue to deliver strong system-wide sales growth with exceptional returns on capital. Fourth, we will expand our world-class preventive services model to include other services and expand our customer base to include EV owners, OEMs and fleets. Moving to Slide 4. The announced transaction delivers significant value and compelling benefits to all of our stakeholders, representing total consideration of approximately $2.65 billion in cash and $2.25 billion on a net basis. Our planned use of the proceeds will be share repurchases, repayment of our 2030 bonds and other indebtedness and growth capital for Retail Services. Under the terms of the agreement, Valvoline will own the Valvoline brand for all Retail Services globally with a few exceptions, and Global Products will own the Valvoline brand for all products purposes globally. The 2 companies will continue to partner on managing the brand in a consistent, holistic manner and no brand royalty payments will be paid between the businesses. Additionally, Retail Services will procure all motor oil and related products from Global Products pursuant to a long-term supply agreement. As a gross company, we will utilize our capital structure and capital allocation policies as levers to drive shareholder value in a manner consistent with best-in-class peers. Following the transaction, we will target a 2.5 to 3.5x leverage ratio, discontinue the dividend and return excess cash to shareholders via share repurchases. Reinvestment in our business and operational excellence, combined with the capital allocation policy, should drive an EPS CAGR of more than 20%. Lastly, we anticipate the transaction to close late in calendar year 2022 or early 2023, subject to customary closing conditions and regulatory reviews. As we turn to Slide 5, we are confident Aramco is the right home for Global Products as they intend to be a long-term partner to the business, operating Global Products as an independent wholly-owned subsidiary. Throughout our discussions, Aramco expressed how much they value the Global Products team and its track record of innovation, supply chain capabilities and significant customer insights. By leveraging Global Products differentiated strengths, along with Aramco's proven leadership in energy supply, Global Products is well positioned to grow as a global leader in lubricants under Aramco's ownership. By capitalizing on Aramco's leading base oil production and Global Products' deep customer relationships, the announced transaction will generate significant opportunities to drive Global Products' long-term success. And importantly, Aramco is committed to partnering with Retail Services. Our customers will continue to have proven trusted portfolio of Valvoline products within our Retail Services locations, which will support the continued growth of both businesses. Let's turn to the next slide. As I noted, this transaction represents the completion of our multiyear transition from a products-focused model to an auto aftermarket services business. Since 2017, Retail Services has grown from roughly 1/3 to more than half of our adjusted segment EBITDA today. Moving forward, we expect Retail Services to continue delivering peer-leading performance. The transformation to a service-driven company has and will continue to drive faster growth, higher margins and stronger returns for our shareholders. At the same time, this transformation supports our ability to further reduce the margin volatility of our business and diminish our exposure to raw material price fluctuations. Our focus on a differentiated customer experience will drive our success with an evolving car park. As we show on Slide 7, the foundation of Valvoline's go-forward value proposition is fueled by our many advantages that differentiate us from our peers. Our 150-year-old brand that stands for quality, trust and convenience, helps us both acquire new customers as well as extend our relationship to additional services with existing customers. We have an extensive footprint throughout North America of nearly 1,700 stores, but with significant opportunity to expand beyond the 15% of households we serve today. And with our strong franchisee partnerships, we can drive store growth while moderating capital intensity. Our proprietary technology and operating model have kept us ahead of competitors in delivering a consistent and superior in-store experience that drives customer loyalty, and our strong culture and teams fueled our ability to drive consistent growth and financial performance. Taking all of these unique strengths together, we have the right components to drive outstanding, sustainable top and bottom line growth. Turning to Slide 8. Our competitive advantages have allowed our Retail Services business to deliver peer-leading performance over the past 5 years. Through transaction growth and ticket expansion, we've grown system-wide same-store sales at an exceptional 10% average and steadily expanded our retail footprint at a CAGR of over 9% since 2017. This has led to outstanding system-wide sales growth at CAGR of almost 18%. Growth will remain a function of our proven success in driving same-store sales and unit growth. This includes company new builds, franchise additions and acquisitions. Let me walk you through how the transaction would impact our EBITDA margins on a pro forma basis for 2022. The sale of the lower-margin Global Products business will improve margins by 800 to 900 basis points, partially offset by the dis-synergies of stand-alone corporate cost and a new supply agreement. Pro forma 2022 margins are slightly below our long-term expectations, primarily due to the price-cost lag from the extreme raw material inflation that we have seen this year. The brand use for product purposes is reflected in the transaction consideration and so no brand licensing fees are involved going forward. The improved company margin profile, coupled with optimized capital structure and capital allocation is projected to drive 20% or more of EPS growth annually. Let's see how this performance compares to peers on the next slide. Valvoline has and will perform favorably compared to both high-growth retail peers and auto aftermarket service companies with our track record of top and bottom line growth, strong returns on capital and market leadership. As a combined company, we have traded at a significant discount to auto aftermarket service and retail peers. As a pure-play Retail Services company, Valvoline presents a compelling value opportunity for investors. We are bullish on our capabilities and opportunities in automotive aftermarket services. Before we open the line for questions, I would like to reiterate the substantial benefits of this transaction. On our road map to drive shareholder value, 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. We will maximize the potential of our core business via increasing market share and driving increased non-oil change revenue growth in our existing stores. With a footprint of nearly 1,700 stores that currently reaches less than 15% of households, we have significant opportunity for unit expansion, and we will be increasing our emphasis on franchisee growth. Finally, with a clear corporate 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 recognize our teams across Valvoline. We say at Valvoline that it all starts with our people. The talent across our organization has never been stronger. I'm proud of the results they've delivered in a challenging environment while also executing the robust process leading to the announcement we are making today. It gives me confidence that we are ready for this next step in our transformation. I want to thank each and every person on our team for their contribution and commitment to our success. With that, I'll hand things back to Sean to open the line for Q&A.

Thanks, Sam. Before we open the line, I'd just like to remind everyone to limit your questions to 1 and just a couple of follow-ups so that we can try to cover everyone on the call. So with that, Chequita, please open the line.

[Operator Instructions] The first question comes from the line of Simeon Gutman with Morgan Stanley.

Congratulations, Sam, Mary and team and Heidi, Lori, if she's in the room. My first question is, in theory, the multiple of combined business or new business goes up, your currency goes up, in that regard do you intend to grow faster through acquisition? And then what's the implication if you do, on the margins of the business? Does it mean they ramp faster or slower?

Yes. We would certainly expect expansion in our multiple, and we do think that creates opportunities for the company, especially as we think about longer-term strategies. So we see it as opportunity -- new opportunities open up for Valvoline with multiple expansion but the key focus for us is growing our preventive maintenance business where we have significant competitive advantage and significant opportunities for continued growth. And so it's that core business that we're so bullish on that we'll be very focused on in the years ahead. And we do think as we grow that business, the opportunity for margin -- continued margin enhancement and strength is important.

And Simeon, I would add on to -- If I could just add on to it. I do think we want to make clear that our intention is to return a significant amount of the proceeds from the transaction to shareholders, likely in the form of share repurchases. We will have some debt reduction that's required as well that we mentioned in the comments. So my belief over the next -- the near-term future is the types of acquisitions we'll be focused on will be the type that we've done in the past where we're adding stores through acquisitions of smaller regional players in a way that we can expand our fleet. And we also have significant plans for expanding through much faster franchise growth. So I think both of those things is what you should be thinking about for growth in the near term for the business.

Yes. So these are really important points for all investors to understand is that first of all, the majority of the proceeds from this transaction will be distributed through a share repurchase program. On an ongoing basis, we'll continue to invest in the business for growth, first, looking for those opportunities to strengthen the business. And then secondly, excess cash, we would expect to be part of a share repurchase program ongoing.

Maybe just the related follow-up. If you could just remind us when you purchased the smaller core acquisition targets, do those ramp quicker, organic investment that maybe take longer? That was the question. Like how does that -- what's the implication if you do more of those relative to the mix? And maybe you're saying you're not going to even do more of those.

No. We've had tremendous success over the last few years making those acquisitions, those regional acquisitions and smaller acquisitions. And yes, they -- we tend to buy high-quality operations focused on great real estate. And then when you integrate and add the capabilities of our process and our team, our digital programs and of course, the Valvoline brand, we're able to drive that performance very quickly. So those tend to ramp really quickly when we're making acquisitions. Whereas new stores take a little bit longer, they typically are in the year 3 before we're hitting, what I would call, more mature level type performance. So we've had success making these regional acquisitions. There's not as many of those regional opportunities out there. There's a lot of smaller acquisition opportunities. So our marketing efforts have changed somewhat, but we're having really good success. And so this year, our expected store growth is in the 150 store range, and so the key thing that you heard in our presentation is that continuing to grow our system is a major opportunity for us. We're reaching less than 15% of households that are within a 5-mile driving distance and so we're going to continue to reach more households with the industry-leading model for preventive maintenance.

The next question comes from the line of Mike Harrison with Seaport Research Partners.

Let me add my congratulations. As you think about using some of these proceeds to drive faster Retail Services growth, should we think of that as basically being additional capital to fund new stores and these acquisitions that you just spoke of? Or -- you mentioned expanding non-oil change revenue. I think I'm curious to understand what new growth avenues might be opening up as a result of this transaction?

Mike, this is Mary. We already make a major investment in capital and growth in the Retail business on an annual basis. I see that investment growing modestly to drive more ground-up store growth and more acquisitions. But I wouldn't say that it's going to be substantial. If in the fiscal year '22, we spend about $160 million of our total capital on Retail Services, I think over the next several years, you could see that grow to the $200 million range or slightly above. I do believe that the majority of the proceeds will be used for returns to shareholders and the balance sheet in terms of required debt reduction. As it relates to non-oil change services, we're very focused on continuing the expansion of the programs that we have in place, and we're piloting other types of services that we are optimistic about within the environment. And I think what you're going to see us is accelerating some of those opportunities to expand some of the other non-oil change services we provide in the store while we're growing the network to expand and reach more customers over time. Sam, anything you'd add to that?

Yes. The non-oil-change revenue opportunity is less a capital investment opportunity and more an investment of our people resources. And the focus of our team, it's about better execution in the stores in presenting those services, executing those services. And so we're definitely investing our time and effort to continue to grow that. It's been an important -- increasingly important part of our mix when it comes to ticket growth, and we see tremendous opportunity. One of the biggest challenges in the broader automotive aftermarket service business is that there's a real shortage of mechanics that's impacting dealerships and repair shops. And their focus more and more has got to be on heavy repair. And what that does is it just creates a big opportunity for Valvoline in preventive maintenance. And so that is going to be our primary focus in capturing more dollars there, more of these non-oil change services. So that's where our investments will be more from an SG&A or people focus. You've heard us talk about our fleet opportunity. That's another opportunity to reach more customers. Fleets are roughly about 10% of the business today, and yet we feel like we're just scratching the surface in terms of the potential to provide preventive maintenance services to more and more fleets.

All right. And then in terms of the approval process, can you talk about what countries will need to provide antitrust approval, any jurisdictions where you have concerns? And also, will the transaction come under review by the committee on foreign investment in the U.S.?

Yes. All good questions. So there will be a CFIUS review and also a review of market competition in certain countries. I don't have a list of those countries, Mike, I know that's critical. When we look at the combination of the business, we do not see any issues whatsoever with regard to how our businesses come together to create any concerns for regulatory bodies.

If there is an anticompetitive review in multiple countries, Mike, but we believe that process is -- will be -- that it's really just a process of going through getting those applications reviewed, we don't believe it will serve as a concern from a closing perspective, but it will take some time just to get through those processes.

The next question comes from the line of Jeff Zekauskas with JPMorgan.

How long is your long-term supply agreement with Aramco? And are the financial terms of that agreement more favorable than what you have today when you purchase oil?

So the long-term agreement, Jeff, is for 10 years. It's going to be market-based in its approach how the pricing works. And we think that the terms are appropriate for both parties that it provides Valvoline Retail Services with the highest quality products and high levels of service to support our growth and for Valvoline Global Products, it provides them an important predictable cash flow that will grow -- continue to grow over time. And so I essentially believe that the partnership is really critical between Retail Services and Global Products. Supply is going to be a big part of this, and it's going to be an important agreement and productive agreement for both parties. With regard to like how does it compare versus how things work today, we're structured differently where our supply chain has been owned by Valvoline. And so Valvoline Retail Services has had to purchase product from Global Products in the past. So this is a new dynamic to the relationship. And so there is some level of dis-synergy that has to be accounted for in the future of Valvoline Retail Services for Valvoline going forward. And that's what we tried to lay out in the presentation on Page 9 there.