Driven Brands Holdings Inc.

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 3/5

Driven Brands is a leading automotive services company, primarily operating through franchise and company-owned locations in North America, Europe, and the Asia-Pacific, with a diversified range of service offerings spanning the automotive aftermarket.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview and Revenue Distribution

Driven Brands operates in four main segments, each with unique characteristics:

  • Maintenance: This segment comprises oil changes, filter replacements, and other basic preventative maintenance services for vehicles. It’s often seen as a stable, recurring revenue stream due to its repeat customer base and the necessity of these services.
  • Car Wash: This segment provides both full-service and express car wash services. The model relies on convenience, speed, and strong location strategies for attracting customers.
  • Paint, Collision, and Glass: This segment focuses on vehicle collision repair, paint jobs, and glass replacements, catering to both insurance-related claims and out-of-pocket customer expenses. This segment has higher revenue per transaction but a cyclicality based on accident frequency.
  • Platform Services: This segment includes the franchisor operations of Driven Brands, where they license their brand and operating system to third parties. It includes the marketing, sales, training, technology, and other services offered to the franchised network. It is a mix of fixed and variable revenues and a high margin business, as the Company mostly provides services and training to its franchisees.

Geographically, Driven Brands generates most of its revenue in North America. The expansion of the carwash segment into Europe and the Asia-Pacific, however, is generating significant growth. Franchise agreements and other partnerships also extend the company’s reach across these markets.

Industry Trends and Competitive Landscape

The automotive aftermarket industry is generally stable, driven by the necessity of vehicle maintenance and repairs. Key trends include:

  • Increasing Vehicle Age: As cars age, they tend to require more maintenance and repairs, thus creating demand.
  • Technological Advancements: Advanced electronics and materials, particularly in new-generation vehicles, create needs for specific diagnostics and expertise.
  • Consolidation: The industry is experiencing consolidation, as large firms acquire smaller independent players to gain scale and market share.
  • Franchising Model: The franchising model is proving popular, as it helps in quicker expansion with a lower capital requirement for the company while ensuring a certain level of consistency in service delivery.
  • Digitalization: Increased digitalization is impacting the industry as well, through online booking and digital marketing.

Driven Brands faces competition across all segments. The competitive landscape includes:

  • Large national players: Companies with a large scale that provide similar services across all sectors.
  • Independent providers: Smaller firms that specialize in particular niches like car repair, glass, or auto painting.
  • Franchise Networks: Other automotive service companies with a franchise model that aim to expand rapidly.

Driven Brands distinguishes itself primarily through its diversified model that can capture cross-selling opportunities and through the ability to develop brands and technologies.

Margins and Financial Performance

Driven Brands’ gross margin has shown to be relatively steady across time, although varying across its business segments, and EBITDA margins are typically lower for segments requiring large upfront investment, such as car washes. Operating margins show great improvement over time as new franchises and locations are added. Net income has struggled, particularly due to interest expense and goodwill amortization related to recent acquisitions. Free cash flow is important to Driven Brands, as it signals its ability to fund expansion opportunities.

  • Driven Brands’ adjusted EBITDA increased by 5% to $193.2 million from $184.9 million compared to the third quarter of 2022, and adjusted net income increased by 10% to $64.2 million in the same period

  • Driven Brands repurchased shares for $25 million in the third quarter, bringing the total repurchases year-to-date to $74.8 million.

  • As mentioned above the free cash flow generation is very good at $71.3 million, while capital expenditures came in at $29.1 million.

Moat Analysis Driven Brands has a weak moat rating of 2/5. While the company’s diverse range of services and strong franchise network provide some competitive advantage, their moats are not as deep or wide as desired.

  • Intangible Assets: Driven Brands does own a recognizable brand and have high brand recognition. Though a large brand, there does seem to be low customer stickiness as consumers can easily move to competing firms. Moreover, their business models does not necessarily generate a willingness to pay more, so even though well recognized the moat does not have a major impact.
  • Customer Switching Costs: Companies that have switching costs provide an advantage, but switching costs are limited. There is some lock-in via their loyalty programs and because of the amount of time required to do car maintenance, but this does not form a strong moat. Customers are always free to move to competitors, particularly for car washes, and collision repair.
  • Network Effects: While Driven Brands is creating a network of car maintenance businesses, they are ultimately competing with other car maintenance businesses, and the network effect does not lead to a competitive moat that makes it much harder to compete with Driven Brands. The network effects are also limited on the consumer side because each location typically can only serve a limited number of people nearby. The network effects do allow Driven Brands to increase brand awareness, but do not create a very strong moat.
  • Cost Advantages: Driven Brands is a franchisee heavy business, so economies of scale are limited because they are ultimately many small businesses which are difficult to scale in unison. This, in turn, leads to average cost advantages rather than strong advantages.
  • Size advantage: Driven Brands has a large size, but their size is not so great as to give them a very strong cost advantage. They do benefit from better distribution and have brand awareness as an advantage, but scale is not a very strong moat for the business, especially in the franchise market, where competitors can easily establish new businesses.

Therefore, given a moderate brand, limited switching costs, weak network effects and only modest cost advantages, we will have to give the business a weak moat rating.

Risks to the Moat and Business Resilience

Several risks could erode Driven Brands’ competitive position:

  • Intensified Competition: With the automotive aftermarket industry consolidating, the business is facing stiff competition. This can lead to pricing pressure and reduced market share.
  • Technological Disruption: Rapid advancements in automotive technology (e.g., electric vehicles, autonomous driving) could alter service needs and render parts of the current infrastructure obsolete. The transition to EVs will likely change much of Driven Brands’ business model. As we move into EVs, will customers even need oil changes? What about other areas of maintenance that these car owners previously required?
  • Economic Downturns: Economic recessions can drastically reduce consumer spending on vehicle maintenance, causing reduced profits across the chain, and a much greater emphasis on price rather than quality for car repairs.
  • Brand Erosion: Failure to maintain consistent service standards can hurt brand reputation and reduce the number of repeat customers. This could arise if some individual franchises fail to perform as well as others.
  • Acquisition Risks: A large portion of Driven Brands’ growth is driven through acquisitions. Overpaying for a given target or failing to properly integrate that acquired business, can materially harm profits.

The company’s resilience will depend on its ability to maintain margins even as its franchisees or competitors increase their prices, whether they are able to expand their service model to match new customer preferences and needs, and whether they manage to grow well while maintaining a strong reputation.

Management’s View and Concerns

Management is focused on growing both through acquisitions and organic growth. The company believes their strategy will allow them to both generate revenue and expand their influence across many markets. Management has stated an intention to focus more on high-growth regions like Europe, and they have also been vocal about their goals for expansion in their car wash segment. A major strategic priority is the continued rollout of Driven Analytics, a proprietary software suite they have. By improving sales and performance, management also aims to increase the profits of their franchises, which should in turn further increase the amount of money the company makes. The main focus of Driven Brands is on recurring revenue segments.

  • Management is planning for continued growth into both company owned and franchised units.
  • Focus is being given to improve technology (such as data analytics) and improve efficiency, while keeping costs down.
  • The company has a strong focus on debt management, and they are consistently focused on maintaining financial stability while expanding their reach.

Understandability Rating: 3/5

Driven Brands’ business model is relatively straightforward: they provide automotive maintenance, repair, and related services through a mix of franchised and company-owned locations. However, the different segments operate in various ways with different risk characteristics. There is added complexity due to the company’s different operations across multiple geographies, which can lead to some confusion. The company’s heavy focus on acquisitions can also introduce complexities that make the business less transparent. Therefore the business gets a score of 3.

Balance Sheet Health: 3/5

Driven Brands carries a moderate level of financial risk:

  • A significant amount of debt as the company grows through acquisitions, though they have a plan to reduce their net debt to adjusted EBITDA ratio to under 4x by 2025.
  • The company’s cash balance, while adequate, is not huge, and it could be lower following further acquisitions.
  • The company’s goodwill and intangible assets are roughly equivalent to equity, indicating that a large portion of their assets are based on things that have low liquidity.
  • Debt covenants have been adjusted to account for their new debt, which implies that the company has the flexibility to adjust their debt obligations according to performance. This flexibility is somewhat limited by interest rates and external market conditions.
  • The maturity schedule of the senior secured notes are favorable, and the next set of maturities will not be due until 2027.

The balance sheet is not very strong, but they are also not very weak. Although the debt level is somewhat high, the positive cash flows and profitability do provide some assurances. They also seem to be taking steps to reduce their debt over time. All in all the business gets a balanced score of 3 for its balance sheet health.