Driven Brands Holdings: FY23 Guidance Gives Confidence; Continue Staying Long

Overview

The solid guidance for Q4 and FY23 makes me even more confident in making a purchase of Driven Brands Holdings (NASDAQ:DRVN). My investment thesis is being bolstered by DRVN's encouraging fourth-quarter performance, FY23 EBITDA guidance, and positive comments on the company's growth segments. Importantly, the company's positive trajectory and expected double-digit compounding growth rate have not changed. The $590 million EBITDA targeted for FY23, representing 15% y/y growth, is doable in my opinion. Given that the guidance does not account for M&A, DRVN may even end up exceeding expectations. Using consensus estimates, if we assume the same forward EBITDA multiple of 12x on FY25 $735 million EBITDA, that translates to $8.8 billion enterprise value or $5.2 billion in market cap (~$31/share or 12% upside).

Car wash performance

When comparing results across quarters, car wash has certainly lagged behind. In 4Q22, this trend continued with SSS of -10.1%, decelerating from 3Q22 on a constant currency basis, and EBITDA declining slightly on a y/y basis. In my opinion, the car wash industry has a lot of potential, and DRVN's dominant market share and initiatives should fuel its rapid expansion in the years to come. However, the weaker-than-anticipated performance is likely to persist until 2H23 due to the disruption caused by the rebrandings and the volatility in macroeconomic indicators and foreign exchange rates. However, there are some optimistic indicators, such as the newly rebranded locations performing well in comparison and a 12% sequential increase in Wash Club membership. In addition, the market environment has become more reasonable, as M&A and new business ventures in the industry have slowed down, which is favorable for DRVN as a leading player in terms of market share.

Leverage

The fact that DRVN's EBITDA expansion is being driven by higher leverage and inorganic growth is, in my opinion, the perceived weakness by many investors. I disagree with this assessment, as I find that new units economics and roll-up strategy contribute positively on a ROIC basis. But, I do agree that leverage has remained high despite the growth in EBITDA. Also, company-operated units are driving much of EBITDA growth, but they require more capital expenditures, have lower margins, which in turn translates to a lower valuation relative to franchise EBITDA. My view is that DRVN financial position should eventually increase as it increases its cash flow from operations and boosting its EBITDA, which should lead to a reduction in leverage by FY23.

Guidance

Management guided to an adjusted EBITDA of $590 million for FY23. This represents 15% growth and a margin of ~25%, which is higher than the consensus estimates of $583 million. My opinion is that if DRVN is successful in expanding its market share, which it very well might do thanks to rising consumer familiarity with the company's brand and the success of its efforts to increase its share of consumers' discretionary spending, then actual results may exceed projections. Also, I believe that the car wash industry will recover sooner than expected, which could boost same-store sales by more than just the mid-single digits. Additionally, margins could be higher than anticipated if DRVN is successful in keeping costs down even more so than anticipated.

Additional thoughts on share price and valuation

I am surprised that DRVN's stock price has remained essentially unchanged despite the company's impressive revenue and EBITDA growth, which has more than doubled since 2020. I would have expected the stock price to grow in line with the business's EBITDA, but instead, multiple compression has counteracted the stronger EBITDA growth, limiting the stock's performance. I believe that the current 12x looks too low for a company with durable mid-teens EBITDA growth, especially given DRVN's core fundamentals. That said, even assuming the current multiple, there is still a potential upside of 12% if DRVN meets the FY25 consensus estimate.

Conclusion

DRVN posted 4Q22 adj. EBITDA of $130.5 million, surpassing the expected $125.5 million and fueled by higher margins. The highlights of the quarter include a promising forecast for FY23 adj. EBITDA, with potential for more positive results. Nonetheless, retail exposure is anticipated to impact the car wash segment during at least the first half of 2023, and DRVN's variable rate exposure is a challenge as rates increase. I continue to think DRVN is a buy as I am optimistic about DRVN's different end markets and long-term growth potential.