Description

Until recently, Valvoline operated through two segments, Retail Services and Global Products; however, the Company recently announced the sale of the Global Product business, which is discussed further below. Through Retail Services (i.e., RemainCo), Valvoline operates the second largest chain of oil change centers in North America, with a network consisting of approximately 1,700 system-wide stores, including ~800 company-operated stores and ~900 franchised stores. Through Global products, Valvoline sells vehicle motor lubricants and related accessories through the North American do-it-yourself channel (i.e., retailers such as AutoZone, Walmart, etc.), the North American installer and do-it-for-me channel (i.e., third-party automotive service providers), and internationally to a long-tail of retail and wholesale distribution channels. On August 1, 2022, Valvoline announced the sale of its Global Products segment to Saudi Aramco; this sale is expected to close towards the end of calendar year 2022.

The thesis on Valvoline is baed on the following tenants which are topical in the current market environment:

• Valvoline Retail Services is a good business with secular growth: the business exhibits predictable, steady and defensive demand, demonstrated pricing power, and attractive unit economics and growth characteristics, all of which have resulted in the Retail Services business having a high-teens-plus EBITDA growth algorithm, which we expect to continue going forward
• Valvoline has a self-determined balance sheet: following the sale of Global Products, the Company will be net cash (before deployment of the proceeds) with no need for near-term debt issuance
• Valvoline has below average cyclicality of earnings with near-term accelerants to its "normal" growth profile: Retail Services has had 16 consecutive years of positive same store sales growth, including +4% y/y and +7% y/y same store sales growth in 2008 and 2009, respectively, and +2% same store sales growth in 2020 despite COVID-related lockdowns; this below average cyclicality will be enhanced in the near-term through accelerated store count expansion and the potential commencement of an input cost deflationary cycle
• Valvoline has drivers of value: following the sale of Global Products, the Company has outlined that it will deploy ~30% of its market cap through repurchases during 2023, moreover, as the Company will be a pureplay retail business, the multiple should re-rate higher towards best-in-class retail comps

Valvoline Retail Services is a good business with secular growth

Valvoline's Retail Services business is a strong business, exhibiting predictable, steady and defensive demand, a high degree of brand equity, demonstrated pricing power, attractive unit economics and a high degree of industry fragmentation, all of which create highly predictable revenue, favorable competitive dynamics and best-in-class growth characteristics for Valvoline

• Brand Equity: Valvoline is one of the most iconic brands in motor lubricants, benefiting from its status as the petroleum industry's first US trademarked motor oil brand in 1873. The brand equity is evident in both consumer surveys, where Valvoline's instant oil change service centers consistently rank among the most trusted an dhighest ranked automotive service centers, as well as in the Company's best-in-class unit economics and growth metrics (see below)
• Predictable, Steady and Defensive Demand: at the end of Valvoline's fiscal year 2022 (note: the COmpany has a fiscal year ending on September 30, 2022), Valvoline's business will have generated sixteen consecutive years of same-store-sales growth, including COVID, when same-store-sales growth grew +2% y/y despite lockdown related mobility restrictions
• Demonstrated Pricing Power: Valvoline's Retail Services segment has never had a down year in pricing in its history, and it has proven its ability to both manage periods of input cost inflation as well as maintain pricing during input cost deflationary cycles 
• Favorable, Secular Mix Shift: Valvoline benefits from the industry-wide shift towards higher-ticket synthetic lubricants, which has been driven by the proliferation of smaller displacement turbocharged engines, escalaging corporate average fuel economy ("CAFE") mandates and government regulations to lower tailpipe emissions
• Attractive Unit Economics and Growth Characteristics: 1) the Company has generated historical 5-year same store sales CAGR of +10% and historical 5-year sales and EBITDA CAGRs of +22% and +23%, respectively; and 2) Valvoline generates attractive returns on incremental invested capital, with cash-on-cash returns for new units of >30% at store productivity maturity
• Overstated Electrification Overhang: Valvoline generates the majority of its revenue from oil changes, which are only consumed by inernal combustion engine vehicles, not electric vehicles. However, demand for oil changes is levered to vehicles in the car parc (i.e., vehicles in operation), not the number of vehicels produced in a given year. With that context, it is important to note that even on the most aggressive electrification penetration estimates, the cohort of internal combustion engines that are in the "sweet spot" for Valvoline's Retail Services segment (i.e., 5+ years old) will comprise 95%+ of the North American car parc in 2030 

Valvoline has a self-determined balance sheet

Valvoline's sale of its Global Products segment for $2.25bn of net, after-tax proceeds will enable a strong balance sheet consisting of net cash following the transaction and before deployment of the proceeds from the transaction. As such, the Company will not have a need for near-term debt issuance and, in fact, is retiring its nearest maturity bonds witha portion of the aforementioned sale proceeds. Furthermore, the Company has discussed characteristics of an attractive capital allocation policy, including a constant net leverage target of 2.5x to 3.5x (versus current, pre-transaction net leverage of 2.5x), elimination of the Company's dividend, a healthy amount of reinvestment into expanding the Company's retail footprint (with each store generating >30% cash-on-cash returns at store productivity maturity), and a large amount of repurchases (i.e., ranging from $1.2bn, or 25% of the Company's current market cap, to $1.5bn, or 30% of the Company's current market cap), depending on pro forma net leverage.

Valvoline has below average cyclicality of earnings with near-term accelerants to "normal" growth

Valvoline exhibits below average sensitivity to economic cycles. I mentioned above the secular growth and a-cyclical nature of Valvoline's Retail Services segment (i.e., 16 years of consecutive positive SSS growth, including +4% in 2008 and +7% in 2009, respectively, and +2% in 2020 despite COVID), which is a result of Valvoline's brand equity, predictable and steady demand for oil changes, and Valvoline's relative exposure to the higher income consumer. Furthermore, the Company is selling Globl Products which, while not cyclical in absolute terms, carried a higher cyclicality of earnings than Valvoline's exceedingly stable Retail Services earnings. Notably, following the sale of Global Products, Valvoline's revenues will be 100% generated in North America (i.e., 0% European exposure).

The Company's below average cyclicality will be enhanced in the near-to-medium term through accelerated store count expansion and the potential commencement of an input cost deflationary cycle.

• Store Count Acceleration: the Company's new unit builds are poised to accelerate from ~50 new builds over each of the last two years and 36 new builds in 2020 to up to 75 annual new builds over the next three years, while a renewed focus on franchise growth portends an acceleration from the historical 5-year average of ~65 annual new franhcise openings
• Input Cost Deflation: 1) for context, base oil, a byproduct of fuel production, is the primary input cost of Valvoline's lubricants; 2) base oil prices have inflated ~100% since the onset of COVID, with base oil costs de-coupling from their historical premium to crude oil of ~$2 per gallon to a current premium of ~$6 per gallon; 3) a key base oil supplier recently announced the first reduction in base oil prices since March 2020 - while this initial decline in base oil prices is small, it may indicate that a deflationary cycle in Valvoline's costs has begun; and 4) as Valvoline has largely passed on the recent cost inflation to customers, there is a tailwind on the come from future deflation, as the Company maintains pricing during periods of deflatoin, with the Company never experiencing selling price deflation in its history (this would be additive to the below referenced earnings estimates)

Valvoline has drivers of value

As referenced above, the sale of Global Products will enable a strong balance sheet with the capacity for a large amount of share repurchases. Specifically, the Company has outlined that it will have the capacity to repurchase approximately ~30% of its market capitalization through 2023 and will be eliminating its dividend.

Furthermore, I believe that the sale of Global Products will be accretive to Valvoline's valuation multiple. Before the sale of Global Products, Valvoline did not easily 'fit' within a specific industry classification and, as such, has inconsistent sellside coverage. Specifically, it has been covered by CPG analysts, basic materials/chemicals analysts and transportation analysts. Furthermore, the Company officially falls within the Commodity Chemicals sub-industry index of the S&P 400. I would expect that the sale of Global Products, which leaves the Company as a pure-play, high-growth retailer, will result in a more adequate sellside coverage which, in turn, will enable a turnover in the Company's shareholder base towards retail-oriented investors. 

Taking all of the above together, we find the Company's valuation to be attractive at 13x and 11x my 2024 and 2025 EBITDA, respectively, and 14x and 11x my 2024 and 2025 EPS, respectively. I anchor my valuation on a price target of $45, which is based on 15x my 2024 EBITDA of ~$470mm. This represents ~75% upside to the stock's current share price. 

Catalyst

• Closing the sale of Global Products and repurchasing ~30% of its market capitalization
• Following the closing of the sale of Global Products, the stock should begin to be covered by consumer retail sellsiders and buysiders. As the stock's financials compare favorably to best-in-class retail concepts, this should enable the multiple to re-rate towards best-in-class retail peers
• Base oil deflation: to the extent base oil prices deflate, this would represent a significant tailwind to the Company's margins