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Summary
Following my coverage of Driven Brands Holdings (NASDAQ:DRVN), for which I recommended a hold rating as I wanted to monitor the business’s ability to improve margins over the next few quarters, this post is to provide an update on my thoughts on the business and stock. I am now upgrading my rating to buy as I believe the share price weakness is overdone. While total EBITDA margin is down, car wash EBITDA margin improved significantly, and I foresee two key catalysts that could drive margin to meet management FY26 guidance. Regarding the poor guidance, I believe it was due to management being conservative, and they should have no issues beating it.
Investment thesis
DRVN reported 4Q23 system-wide sales growth of 3% y/y to $1.513 billion, and total same-store sales [SSS] increased 3.9% y/y. Adj EBITDA came in at $129 million, above the consensus estimate of $124.7 million, which translates to an adj EBITDA margin of 23.3% (a 90bps slowdown vs. 24.2% seen in 4Q22). Post-results, DRVN saw its share price drop by >10%, which I believe was way overdone and was primarily due to the weak margin performance and poor guidance.
On margins, while the consolidated margin was down on a y/y basis, there is notable improvement in car wash margins—segment margins increased 600 bps sequentially to 23% in 4Q23 as DRVN better controls variable costs (such as detergent, water, and labor) in the domestic business. Here is where it gets interesting: inferring from management’s comments, these improvements appear to be structural margin improvements, as they expect the 23% level to sustain through 2024, with potential improvement driven by better topline performance in the US. One point to note here is that DRVN is also targeting members with better unit economics as they focus on driving trade-up. As such, while membership penetration has softened (a negative point), it does not mean that the number of members has stopped growing. The number of members continues to grow, and as better unit economics members become a larger mix of the pool, I think margins could inflect higher as management continues to execute on this aspect.
Hey Chris, Danny again. So as far as the Car Wash membership question, look, we don’t get into specific KPIs on the membership side. I will say we’re happy with the fact that in 2023 we did grow members. So that’s good. 4Q23 earnings results call
Management’s Dream Big Plan is also on track, with a target to generate $850 million in EBITDA by 2026. By cadence, they expect growth in 2025–2026 to double compared to 2024, driven by stabilization in car washes and the Glass business unit (more below), upside opportunities from the ramp-up in regional and national insurers for Glass, and economies of scale from the DRVN advantage platform. Specifically on Glass, hearing that integration with Glass is progressing ahead of schedule was encouraging. I expect a high likelihood of acceleration in 2H24 as DRVN begins to reap early benefits from regional insurers. These benefits will continue to pile up into 2025 as DRVN expands its reach to national insurers. Given that by 4Q23, everything has been streamlined: point-of-sale, phone, lead management, payroll, and compensation plans rolled out across all locations, I think this puts DRVN in a stronger position to target national insurers in FY25.
DRVN
As for the poor guidance, I do agree that, on a headline basis, it was not super positive. Management guided to 3-5% SSS growth and $535–565 million of adj. EBITDA, which implies a 22.8–23.1% margin. This is implicitly a guide down (for SSS growth) from management’s previous guide in September 2023, as the high end of the current guidance was in line with the guidance given previously. However, from the way I am seeing it, I think the guide might be too conservative, as management is incorporating headwinds from the macro backdrop and weather at the lower end of its guide. The fact that management actually brought up weather headwind was interesting because they have never noted that as a headwind, so this shows how conservative they are. On macro, I think it’s fair to say that things remain uncertain, but I also want to point out that the macro situation is relatively better than in 2023. While the labor market remains hot and housing remains a problem in the US, at least inflation has come down a lot. Let’s also not forget that DRVN still has a strong maintenance revenue stream that remains solid—printing 4.7% comps growth, reflecting continued strength in Take 5.
Valuation
Own calculation
My target price for DRVN based on my model is ~$19. My model assumptions are that DRVN will meet the high end of revenue guidance, growing 5% in FY24, as I believe management guidance is too conservative considering the relatively better macro in FY24 vs. FY23 and the potential upside from Dream Big and Glass integration. My expectation for FY25 remains the same: ~10% top-line growth. Note that I am also being very conservative on FY25 growth expectations, as management’s FY26 target includes revenue of $3.4 billion, which would imply a CAGR of ~19% from the midpoint of FY24 guidance ($2.4 billion). Importantly, these FY26 targets include little to no impact from M&A, as the targets were formulated using organic growth estimates; hence, there is potential for upside.
As for earnings margin, I have become more confident that margin will accelerate in FY25 to 9% given the focus on driving trade-ups in memberships and contributions from the Dream Big plan. If DRVN were to execute as I expected, I don’t see a problem with DRVN sustaining the current multiples as earnings growth is going to grow much faster than the topline (I expect ~40% earnings growth in FY25). For benchmark purposes, when DRVN grew earnings at 94% in FY22, the stock traded at mid-20s forward PE. My FY25 41%, which is slightly less than half of FY22 growth, implies that DRVN should trade at a low-teens multiple.
Risk
There are a number of potential risks. For one, if the ongoing demand headwinds in the car wash industry persist, it will impact DRVN revenue growth directly. In addition, a major catalyst for margin expansion is the Glass business unit integration; any mis-execution here will impact margin performance.
Conclusion
I am upgrading my rating on DRVN from hold to buy. While the recent share price weakness can be attributed to concerns about margin performance and guidance, I believe this is an overreaction. Despite a slight dip in overall margins, the car wash segment is experiencing significant margin expansion. This demonstrates DRVN’s ability to effectively control costs and improve profitability within this core business unit. Also notably, the integration of Glass is progressing ahead of schedule. Lastly, I believe management’s guidance is overly conservative, incorporating potential headwinds from the macro environment and weather into the lower end of the range. While some uncertainty persists, the overall macro situation in 2024 appears slightly more favorable compared to 2023.
