Monro, inc limited upside for now – monro, inc. (nasdaq mnro) seeking alpha youtube gas station karaoke


Monro Muffler Brake, Inc. ( MNRO) is an American automotive service company focusing on scheduled maintenance, undercar repairs, and retail tire sales. As of May 21, 2018, the company operated 1,166 stores in 27 states, primarily in the northeast.

Over the last 5 years, MRNO has underperformed the auto parts sector by 10% on an annualized total return basis (Figure 1). MNRO has been amongst the leaders in terms of sales growth, increasing revenues at a CAGR of 8.7% compared to 7.2% for the peer group, but this growth has come entirely from acquisitions and new store openings. Same store sales were negative every year between 2013 and 2017, and last year’s decline of 4.3% was the company’s worst since 2013.

Margins have remained stable for the most part, but the company’s acquisition-led growth model has hurt shareholder value in recent times. Between 2013 and 2017, returns on capital steadily declined from the low teens to the mid single digits, and it seems like MNRO’s core markets in the northeast have reached saturation. After taking into account the cost of acquisitions, free cash flows aren’t growing, and the company’s FCF conversion rates average less than 1% of sales.

Peers, on the other hand, have been doing very well. Advance Auto Parts ( AAP), AutoNation ( AN), AutoZone ( AZO), Group1 Automotive ( GPI), LKQ Corp. ( LKQ), and O’Reilly Automotive ( ORLY) reported positive same store sales growth in most if not each of the last 5 years and generally saw solid improvement in margins and returns on capital. MNRO’s inferior organic growth and profitability meant that its historical valuation discount to peers was fully justified. But now, Monro trades at a sizeable premium to peer group valuations (Figure 2), and we can’t quite figure out why.

MNRO is actually slightly cheap compared to its long-term averages, but competitors are trading at much steeper discounts to their own long-term "mid-cycle" average valuations. This is because the latest auto cycle peaked recently, and the industry is likely in for a stretch of soft or even negative growth. Given that there isn’t a lot that separates MNRO from its competitors, we’re struggling to see why MNRO’s multiples haven’t contracted like the peer group‘s.

You could make the case that MNRO is purely a repair business, while certain competitors also have significant new/used car dealership operations. The logic is that the repair/maintenance business is set to flourish due to all the new cars sold in recent years that are now entering that "sweet-spot" repair age, while dealership businesses will lag now that car sales are declining.

But the repair industry has been running at close to optimal conditions for many years. Both the total number of light vehicles on the road (Figure 3) and the average vehicle age (Figure 4) have steadily increased since the financial crash, while gas prices, on average, have gone down. It’s hard to see how a continuation of these trends will make a huge difference for MNRO, whose performance has been so mediocre over this period. If pure-play maintenance/aftermarket competitors benefit from these trends the same way MNRO does (and theoretically they should), then MNRO’s premium to these companies doesn’t make sense.

Sales in Q4 increased 13.3%, but this was mainly due to acquisitions and new store openings, while an extra week padded results as well. Same store sales increased 2.4%, and, while this is certainly an improvement over recent years, it’s not something to get overly excited about: same store sales momentum improved for peers as well throughout the year, and the growth in Q4 was more or less the same as competitors, who averaged SSSG of 2.2% in the latest quarter. MNRO isn’t doing anything differently than peers, and, while management’s strategic initiatives may have helped, the company only expects to grow comps ~1% next year.

On the profitability side, operating margin improved 270 bps to 10.7% in Q4 mainly due to leverage from higher same store sales. But, for the year, operating margin declined slightly to 11.3% as a shift in product mix from new acquisitions weighed on profitability. Next year, management expects an operating margin of 11.1% based on the midpoint of sales guidance, which implies a 20 bps decline from this year and a 170 bps decline from two years ago.

MNRO’s 3-year targets are as follows: same store sales growth of 2-4%, operating margin back above 12% and consistent 10-15% earnings growth. You can read all about management’s initiatives in the investor presentation, but it’s not enough to sell us on Monro. An operating margin of 13% is the absolute upper limit of the company’s historical profitability range. So, even if management executes, there’s very little margin upside here.

Investors are also exposed to more uncertainty than they were before now that growth will increasingly require MNRO to expand into adjacent and less familiar markets. It’s not exactly clear if MNRO’s stores were cannibalizing each other in core markets, but the weak comps suggest they might have been. In any case, MNRO will have to open more and more stores in new markets, and there’s no telling how well the brand will translate. MNRO operates in the "do-it-for-me" repair segment so brand, reputation, and trust go a long way, and increased investments in marketing and advertising may be necessary. Conclusion

Management has an optimistic tone, but investors should hold off on MNRO. The company’s acquisition-driven growth model may generate higher sales, but it’s not generating higher free cash flows. Even if management executes, the margin upside is limited, and the risks that come with such a strategy are significant. Furthermore, execution will probably require a continuation of favorable industry trends, but the fact that MNRO hasn’t performed even when conditions have been close to ideal doesn’t inspire a lot of confidence.

MNRO’s premium to the peer group doesn’t make a lot of sense in light of the company’s weak comps and poor FCF conversion. Nothing has materially changed between MNRO and its competitors to warrant a premium of this magnitude, and the latest quarter confirmed that MNRO isn’t doing anything above and beyond its competitors.