Morningstar | Reasons for Valvoline's Tough 3Q Appear Transitory; Shares Attractive
While we plan to trim our short-term forecast for narrow-moat Valvoline after a soft third quarter, which is likely to lead to a mid-single-digit percentage dip in our $24.50 fair value estimate, we do not believe the results indicate a change in the company's long-term prospects. As such, our 10-year targets for mid-single-digit sales growth and 22% adjusted EBITDA margin, on average, should not change materially. We see the shares as attractive, with sentiment underestimating the strength of Valvoline’s premium lineup.Year to date, Valvoline saw 10% sales growth against a 20% adjusted EBITDA margin. Management cut its fiscal 2018 guidance to 9%-11% revenue growth (from 10%-12%) and adjusted diluted earnings per share of $1.26-$1.31 (from $1.31-$1.38) versus our 10% and $1.34 respective marks.
Domestic volume disappointed, down 1% year to date. While we had expected flat results for the fiscal year, we are encouraged that the source of the shortfall was the firm's lower-margin conventional and unbranded lineup. Higher-end products have accounted for nearly half of U.S. branded volume in fiscal 2018, up from around 30% in fiscal 2013. We believe Valvoline's continued premium mix improvement, which included a 470-basis-point third-quarter uptick from the same period last year, indicates that its brand remains strong and poised to capitalize on a long-term demand shift toward higher-end products. Furthermore, we expect profitability to improve in the fourth quarter and into fiscal 2019 as price increases take effect.
International volume also lagged, up 1% year to date versus our mid-single-digit expectations. Still, we expect recovery in fiscal 2019 as growth remained strong in the critical Chinese and Indian markets (about 9% including joint ventures) and as European and Latin American results were hindered by transitory distribution disruptions. We still expect Valvoline's international and instant oil change units to drive long-term growth.
Valvoline is a marketer and supplier of engine and automotive maintenance products and services. The company's segments are: Quick Lubes, which services the passenger car and light truck quick lube market via the company-owned, independent franchises and joint venture retail quick lube service center stores, as well as independent Express Care stores that service vehicles with the company's products; Core North America, which sells Valvoline? and other branded and private label engine and automotive maintenance products in the United States and Canada; and International, which sells Valvoline? and other branded engine and automotive products for the maintenance of consumer and commercial vehicles and equipment.
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