There are nearly 5,000 locations in the Driven Brands (DRVN -0.28%) portfolio. And yet, despite this footprint, the company remains relatively unknown. This obscurity may be why the stock is so cheap right now. And a low valuation gives it the potential to double or more in just the next three years if things go right.
That said, Driven Brands is hardly a no-brainer investment. There are risks that might cause many investors to avoid this stock, as I'll explain.
Meet Driven Brands
Driven Brands owns, operates, and franchises various car maintenance brands such as Take 5 and Meineke, spanning various categories including oil change, car wash, windshield repair, and more. I view these as resilient consumer spending categories.
Driven Brands pursued a growth-by-acquisition strategy to reach its massive size. And given the reality of the space, it makes sense. For example, according to 2019 data presented by car wash competitor Mister Car Wash (MCW 0.44%), nearly three-quarters of the car wash industry is run by companies with only one or two locations. In other words, fragmentation in this space is extreme.
As of the second quarter of 2023, roughly 23% of Driven Brands' portfolio was in the car wash space. But there's similar fragmentation in the company's other segments as well, which is why it's on a mission to roll up these small players. Consider that from 2020 through the end of 2022, the company acquired over 100 businesses.
Driven Brands is pursuing this strategy because bigger companies do have competitive advantages. Consider Mister Car Wash as an example. It just released a new protective finish product called Titanium, which it claims is three times better than anything its competitors have. Moreover, management believes its Titanium program will soon account for 10% of its membership base.
It's hard to imagine a car wash company with only one or two locations developing a product like Mister Car Wash's. Bigger companies simply have more resources for developing products and technologies that put them ahead. This ability can benefit Driven Brands as well.
Additionally, larger companies can benefit from greater name recognition and brand loyalty, which are things Driven Brands' management is counting on.
The opportunity for Driven Brands
Driven Brands' management believes the business will profit at least $850 million in adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) in 2026. For comparison, the company has earned just a little less than $500 million in trailing-12-month EBITDA. Therefore, management is guiding for roughly 70% EBITDA growth in under three years.
DRVN EV to EBITDA data by YCharts.
I believe there's credibility to Driven Brands' 2026 goal. The goal was first announced in the third quarter of 2021 and management hasn't wavered from it. To the contrary, it's made significant progress toward it. Moreover, CEO Jonathan Fitzpatrick only announced the 2026 goal after leading the company to reach its previous EBITDA goal ahead of schedule.
Driven Brands stock is down nearly 50% in 2023 as investors worry about a slowdown in the business. And fears dropped the stock's valuation to an all-time low. If the business can indeed grow EBITDA by over 70% by the end of 2026, this will likely also improve the market's sentiment, leading to a recovery in the company's valuation.
At $850 million in EBITDA, Driven Brands stock would only need to trade at an enterprise-to-EBITDA valuation of 12 to double from today's price. As you can see in the chart above, that valuation would still be well below average for this company.
What could hold it back
Adjusted EBITDA excludes interest from the equation. But interest is a big deal for Driven Brands. Thanks to its acquisition strategy, the company has over $2.8 billion in long-term debt compared with just $212 million in cash and cash equivalents. Interest expense in the most recent quarter was nearly $41 million, up 56% year over year. So while excluding interest expenses will boost the EBITDA metric, real cash left over for shareholders could be substantially less.
So, if business slows down substantially, Driven Brands' debt load could exacerbate -- less revenue could lead to lower cash flow, elevating debt servicing as a percentage of revenue. And there's reason to be cautious about this as well.
For example, in Q2, same-store sales for Driven Brands' car wash properties fell 4% year over year, and management cited growing competition as a factor. By contrast, Mister Car Wash's same-store-sales grew 0.3% for the same period. And when analysts asked about competition, Mister Car Wash's management dismissively said the space has always been, and will always be, competitive.
The risks are real. However, with the company profitable and trading at a low valuation, I believe the downside is limited for Driven Brands stock from here. But if things go right, the upside could be market-beating, which is why this is a stock worth buying for those who are comfortable with the aforementioned risks.
