Valvoline Inc Q4 FY2020 Earnings Call

Ladies and gentlemen, thank you for standing by, and welcome to the Valvoline Fourth Quarter 2020 Earnings Conference Call. I would now like to hand the conference over to your speaker today, Sean Cornett, Head of Investor Relations of Valvoline. Thank you. Please go ahead.

Thanks, Tenia. Good morning, and welcome to Valvoline's Fourth Quarter Fiscal 2020 Conference Call and Webcast. Valvoline released results for the quarter ended September 30, 2020, at approximately 5:00 p.m. Eastern Time yesterday, October 28, and this presentation and remarks should be viewed in conjunction with that earnings release, a copy of which is available on our Investor Relations website at investors.valvoline.com. These results are preliminary until we file our Form 10-K with the Securities and Exchange Commission. A copy of the news release has been furnished to the SEC on a Form 8-K. With me on the call today are Valvoline's Chief Executive Officer, Sam Mitchell; and Mary Meixelsperger, Chief Financial Officer. As shown on Slide 2, any of our remarks today that are not statements of historical fact are forward-looking statements. These forward-looking statements are based on current assumptions as of the date of this presentation and are subject to certain risks and uncertainties that may cause actual results to differ materially from such statements. Valvoline assumes no obligation to update any forward-looking statements unless required by law. In this presentation and in our remarks, we will be discussing our results on an adjusted basis, unless otherwise noted. Adjusted results exclude key items, which are unusual, nonoperational or nonrecurring in nature. We believe this approach enhances the understanding of our ongoing business. A reconciliation of our adjusted results to amounts reported under GAAP and a discussion of management's use of non-GAAP measures is included in the presentation appendix. The non-GAAP information provided is used by our management and may not be comparable to similar measures used by other companies. As we turn to slide 3, let's review our financial results for the quarter and the year. For the fiscal fourth quarter, Valvoline delivered reported operating income of $176 million, net income of $122 million and EPS of $0.66. For the fiscal year, Valvoline delivered operating income of $485 million, net income of $317 million and EPS of $1.69. Full year cash flow from operating activities was $372 million. There were several key items in the fourth quarter, which netted to an impact of $37 million of after-tax income. The largest of these related to nonservice pension and OPEB impact. Including mark-to-market remeasurements, these totaled $24 million of after-tax income. We had a benefits policy change related to paid leave, the approval of which resulted in $9 million of one-time after-tax income. Tax-related key items, including those related to legacy tax assets resulted in $30 million of pretax income and were largely offset in tax expense resulting in a $2 million after-tax benefit. Other key items related to restructuring and business interruption recovery, which combined for $2 million of after-tax income. In Q4 fiscal 2019, key items primarily related to $15 million of pension and OPEB after-tax expense. Excluding key items, results for the current quarter included adjusted operating income of $132 million, adjusted EBITDA of $150 million and adjusted EPS of $0.46. For fiscal 2020, Valvoline generated adjusted operating income of $444 million, adjusted EBITDA of $510 million and adjusted EPS of $1.48. Full year free cash flow was $221 million. Now as we turn to Slide 4, let me turn the call over to Sam to discuss our results and operations in more detail.

Thank you, Sean. My hope continues to be that you and your families are doing well and remaining healthy and safe. I want to take just a few moments to reflect on a truly unique year. In many ways, the COVID-19 pandemic and the abrupt wide-ranging changes it caused made fiscal 2020 one of the most challenging years in my career at Valvoline. It also demonstrated the strength of our team. At Valvoline, it all starts with our people, and the team came through in tremendous fashion helping to deliver record results. The durability of the Valvoline business model was reflected in our rapid recovery from the depths of the COVID-19 impacts, ending the year with outstanding results that drove year-over-year growth in profitability. We have strong momentum as we begin fiscal 2021, and we see next year as an inflection point for the company. Our shift to a service-driven business is accelerating and will drive faster growth in the future, including expected double-digit adjusted EBITDA growth next year. Let's take a closer look at Q4 and fiscal '20 on the next slide. Valvoline's product and service business is focused on preventive maintenance, which remains steady across economic cycles. Our growth is driven by the competitive advantages that we continue to invest in in our Quick Lubes segment and a hands-on customer-centric approach across all of our businesses. Our performance in Q4 was exceptionally strong and generated results that exceeded our expectations. Overall, sales improved 26% and adjusted EBITDA increased by 42% from our results in Q3. These strong sequential improvements happened across all three segments. Adjusted EBITDA and EPS both grew in the mid-teens for the quarter versus last year, driven by improved margins in all segments. For the full year, adjusted EBITDA grew 7%, with the strong performance in core North America lifting roughly flat results in Quick Lubes and overcoming larger COVID-19 impacts in international. We are delivering on the plan we shared at our May 2019 Investor Day. As a result, we're well positioned to see growth accelerate. With Quick Lubes, our highest margin, fastest growth opportunity is expected to generate more than half of our adjusted EBITDA in fiscal 2021. Let's take a closer look at Quick Lubes results on the next slide. System-wide same-store sales grew 8.3% in Q4, demonstrating significant improvement from Q3 and continuing the progress we saw in June. Same-store sales growth in Q4 matched our results in Q1, bookending the most severe impact from COVID-19 in March through May and contributing to full year growth of 2.3%. This year marks our 14th consecutive year of annual same-store sales growth, a testament to outstanding operational performance and in-store execution. Q4 same-store sales were once again driven by both ticket and transactions. Ticket growth was driven by premium mix, an increase in non-oil-change services and pricing. Transaction growth was driven by digital marketing programs and continued growth in new customer mix. This combination helped offset the decline in miles driven and put our performance this quarter in line with our pre-COVID-19 five-year average. Total sales and EBITDA in Q4 each grew in the mid-teens versus last year, driven by same-store sales and unit growth. We added 30 net new stores to the system this quarter, including 22 newly built company stores. Overall, we grew our store count by 6% in 2020 as we continue to build our pipeline, positioning us for fiscal '21 and beyond. We recently announced three acquisitions that will give us a great start on unit growth for fiscal '21. We're adding 26 net new company-owned stores, growing our presence in Texas and expanding in the Pacific Northwest. We're also acquiring the franchise system of 21 stores, primarily in Kansas, a strategic fit for our company store markets in the adjacent geographic area. We can discuss the Quick Lubes outlook for 2021, beginning on the next slide. System-wide same-store sales are expected to grow in the low teens in fiscal 2021. This reflects continued strong operations and recovery from the most significant pandemic impacts in the middle of fiscal 2020. Normalizing for those impacts, same-store sales would grow 6% to 8%, in line with our longer-term target. The new company stores we started building in late 2018, and those added in 2019, will be part of our comp base but still ramping to maturity and accounting for roughly 100 basis points of same-store sales in 2021. Comp stores in our base since 2016 have driven substantial operating leverage. While COVID-19 impacted same-store sales and our efforts to keep stores staffed and open drove modest deleverage in 2020, we expect continued improvement in store-level profitability in 2021. Bottom line, store-level performance continues to be the number one profit driver in this business. As you can see on Slide 8, we expect a very strong year for unit growth in 2021, with 150 stores added or 10% growth at the midpoint of our guidance. This expansion is planned to come from across the system. First, based on our development agreements, our franchisees should add 30 to 40 new stores. Second, this coming year, we anticipate reaching our goal of opening 50 newly built company stores. When combined with the stores we've built and opened in the previous three years, we expect a significant contribution to EBITDA. Lastly, with the acquisitions we've already announced and the pipeline we have in place, we anticipate adding nearly 60 acquired stores. Let's turn to the next slide. The Quick Lubes growth drivers—same-store sales, newly built company stores, franchise unit growth and acquisitions—are expected to be firmly in place for 2021, meeting top-line growth in the mid-20% range and EBITDA growth in the mid-30s, which is partly resulting from lapping the weak Q3 2020 results due to COVID-19 impacts. We see significant long-term opportunity in each of the growth levers. Same-store sales are expected to be driven by transaction growth, including new customer acquisition, and ticket growth from premium mix, non-oil-change services and pricing power. We also have substantial opportunities to increase our household penetration by building and acquiring more stores. Over the long term, we anticipate top- and bottom-line growth in the low to mid-teens range with each of the growth drivers contributing. Let's review core North America's results on the next slide. For North America's Q4 adjusted EBITDA grew nearly 30% year-over-year behind a higher-than-anticipated improvement in gross margins. The majority of the margin increase was driven by ongoing favorable channel and product mix and continuing price-cost lag benefits from lower raw material costs. We saw a continued strong performance in the retail channel, due in part to the effectiveness of our merchandising and promotional strategies in DIY. Retail channel volume grew modestly in Q4 and was flat for the full year, a good sign of progress in our efforts to address challenging DIY category dynamics. We also benefited from our broad-based cost savings initiative during the quarter. Favorable channel and product mix, lower raw material costs and benefits from our savings initiatives also drove full-year margin expansion. Improved unit margins, combined with the expense reductions we implemented during the early stages of the pandemic, offset the impact of lower installer channel volume. The installer channel was significantly impacted by COVID-19. Recovery in the channel continues to build with Q4 installer volumes up almost 50% from Q3. Let's take a look at North America's outlook on the next slide. Core North America's volumes are expected to increase modestly in fiscal 2021. The DIY category is anticipated to be fairly stable with volume down roughly 1% and continued growth in the synthetic segment. Valvoline's retail channel volume is expected to be relatively flat. We have solid merchandising plans in place across the key retailers and price gaps to private label are expected to be steady. Segment growth is primarily due to installer channel volumes rebounding from the significant pandemic impact in 2020. In addition, we expect to continue winning new installer customers with our value-added selling approach. We've recently renewed a number of key national accounts, securing a portion of the installer base and extending our relationships with these important customers. A normalizing channel mix is anticipated to be a headwind to margins, lapping favorable price-cost lag benefits, along with the recent modest increases in raw material costs are the primary drivers of the anticipated low double-digit decline in EBITDA for the upcoming year. Despite the headwinds in 2021, we expect EBITDA to be higher in the low double-digit range over 2019 results, well ahead of our targets that we gave at the Investor Day in May 2019. Unit margins are expected to remain solid, near $4 as the benefits from our cost savings initiative have structurally improved margins from the $3.60 to $3.80 range in the 2018 to 2019 period. Let's look at International's performance on the next slide. The International segment delivered substantial sequential improvement in top- and bottom-line results across all regions in Q4. Volume in the quarter, including joint ventures, was nearly back to pre-pandemic levels from Q1. Versus Q4 last year, China had strong volume growth, coupled with solid performance in Australia and other parts of Asia. This growth was offset by continued COVID impacts in Latin America, EMEA and India, driving the overall year-over-year volume declines in the quarter. An increased contribution from higher-margin geographies and joint ventures as well as overall improved margins drove a 9% increase in segment EBITDA. For fiscal 2020, lower volume, especially related to COVID-19 impacts in Latin America and India led to the decline in EBITDA. We anticipate significant top-line growth in 2021 with volume and sales each increasing in the low double digits, excluding sales from our new China plant to the China joint venture. Although levels of activity could be uneven across geographies, depending on COVID-19 recovery, this broad-based growth is expected across regions. Our new lubricants facility in China recently completed the construction phase under budget and began initial testing in Q1. We expect the plant to come online by the end of the calendar year and be producing essentially all of our lubricant volume for the China market by the end of fiscal 2021. In the long term, logistics efficiencies and the elimination of third-party tolling fees is anticipated to drive meaningful cost savings, while the move to in-house production enhances our standing in the market, creating opportunities for volume growth. We plan to continue investing for future growth through channel and platform development and brand building. The Original Motor Oil global campaign, our new partnership with a football club and our ongoing global partnership with Cummins are key parts of our approach to building brand equity and awareness and capturing opportunities to generate profitable volume growth. Continued SG&A investments and cost to ramp up the China plant are expected to moderate EBITDA growth in 2021 to the high single-digit range, but still in line with our 2019 Investor Day target. Let me now turn it over to Mary to review our financial results and guidance in more detail.

Thanks, Sam. Our adjusted results for the quarter and the year are shown on Slide 14. In Q4, sales increased 4% on flat volume, primarily driven by the strong top-line performance in Quick Lubes. For the full year, sales and volume declines were driven primarily by the significant impacts of COVID-19, particularly in Q3. Favorable mix and price/cost lag benefits in core North America, along with margin improvement in Quick Lubes and International drove the 430 basis point increase in our gross margin rate this quarter. Q4 performance and earlier benefits from mix, price/cost lag and the cost savings initiative we began last year improved gross margins for 2020. Higher SG&A in Q4 was driven by an increase in incentive compensation and a return of advertising and marketing expenses. Full-year SG&A benefited from the expense reductions we implemented as COVID-19 impacts began to expand more broadly and were offset primarily by higher incentive compensation leading to modest SG&A growth in 2020. Overall, significant margin improvements were partially offset by higher SG&A, leading to growth in adjusted EBITDA for Q4 and for the full year. Let's review key corporate items on the next slide. Net interest and other financing expenses increased $20 million for the full year, primarily related to the cost associated with calling our 2024 bonds early, which we treated as a key item in Q2. Our adjusted effective tax rate was consistent with our expectations. Total net pension and OPEB obligations declined by $71 million year-over-year reflecting strong performance and risk management of our pension plans. Full-year free cash flow grew modestly, a $47 million increase in operating cash flow, driven primarily by higher earnings offset by a $43 million increase in CapEx due to investments in new stores and the China plant as well as higher cash taxes. Our balance sheet remains strong with total available liquidity of just over $1.3 billion, including $760 million in cash and cash equivalents on hand. Importantly, we returned $144 million of capital to shareholders in fiscal 2020. Let's review our fiscal 2021 guidance on the next slide. In fiscal 2021, we expect mid-teens growth in sales, benefiting from both strong same-store sales and store additions in Quick Lubes and a return to growth in International. Roughly 100 basis points of top-line growth is attributable to sales from our new China plant to the China joint venture, which we expect to begin in Q4. We anticipate adjusted EBITDA of $560 million to $580 million or 10% to 14% year-over-year growth. This is especially impressive given that we won't repeat the roughly $20 million price/cost lag benefit from fiscal 2020 and are likely to see unfavorable raw material cost pass-through impacts of $5 million to $10 million this year. Fiscal 2021 adjusted EBITDA guidance, when combined with the 7% growth we just delivered, results in a two-year adjusted EBITDA CAGR of 9% at the midpoint, ahead of the targets we set at our Investor Day in 2019. Overall, we expect the quarter-by-quarter performance to vary significantly year-over-year, with Q1 results declining sequentially given seasonally lower volumes and the impacts of recent raw material cost increases, but growing year-over-year. In Q2, we expect to be relatively flat year-over-year as we are comping a $14 million decrease in incentive compensation last year. We anticipate Q3 to be our strongest quarter of year-over-year top- and bottom-line growth due to the severe COVID-19 impacts we saw in 2020. And Q4 should return to a more normal growth pattern. We continue to expect our adjusted effective tax rate to be between 25% and 26%. Given our EBITDA growth and the increase in depreciation and amortization expense from our ongoing growth investments, we anticipate adjusted EPS in the $1.57 to $1.67 range. With the significant unit growth in Quick Lubes from newly built and acquired stores, along with carryover capital in fiscal 2020, we expect a moderate increase in fiscal 2021 capital expenditures. Expected increases in cash taxes of $40-plus million will largely offset higher pretax earnings, leading to free cash flow of $200 million to $220 million. I do want to emphasize that the guidance we are providing is dependent on current expectations, which could be significantly impacted by external factors surrounding COVID-19, such as incremental state, regional and country-specific restrictions or significant changes in miles driven, which we continue to monitor closely. Now let me turn things back over to Sam to wrap up.

Thanks, Mary. We're pleased with the way we've been able to manage through the unique challenges this year from the ongoing COVID pandemic. We took decisive actions and our team focused on safety and adapted to working together and meeting customer needs in new ways. Our business performance over the last five years demonstrates the benefits of our preventive maintenance model. Our diverse product and service offerings across multiple geographies and channels have driven durable adjusted EBITDA growth and solid margins in the face of macro challenges, including raw material cost increases, DIY market changes and now a global pandemic. Over the past five years, we've generated $1.1 billion in free cash flow, averaging $220 million annually, as we did again in 2020 while making significant growth investments. We have consistently generated return on invested capital above 20%. We continue to invest in high-return projects with returns roughly two times our cost of capital. As we realize the benefits of these investments, our return on invested capital is expected to remain strong, while growth accelerates. Let's turn to the next slide. We anticipate 2021 to be an inflection point in our growth trajectory. We have made significant progress in core North America, and we're well positioned for growth in International. Most importantly, the investments we've made in Quick Lubes by building new company stores, making acquisitions and improving operational performance are working. We expect Quick Lubes to be more than half of our adjusted EBITDA next year. This is significant given the segment's high-margin and growth profile. We expect 2021 to be a strong year for Valvoline as we enter a faster phase of growth and accelerate the shift to a more service-driven business. With that, I'll turn it back over to Sean to open the line for Q&A.

Thanks, Sam. With that, Tenia, please open up the line.

Operator: And your first question comes from the line of Jeff Zekauskas with JPMorgan.

Is your general approach to base oil prices that they've risen because of hurricane-related outages and disruptions in the refinery area and that in the course of the next 12 months, they'll probably come down from the levels that they're at? Or do you have a different view?

Yes, Jeff, you're right. The hurricanes have had an impact on the base oil market. There were two base oil increases since last summer. The first was more tied to the increase in the overall crude market, a modest increase, and then the second, that will impact us as we go into Q1, tied to the hurricanes. As far as expectations for the future and what we've built into our guidance, there's really no significant change following this recent round of base oil increases. It is possible that we could see decreases as capacity builds back up later this year, but we're not counting on that in terms of how we built our plan.

And can you talk about the fact that your China expansion will have on operating income or EBITDA in 2021, 2022, 2023 as that investment matures?

So Jeff, on the China plant, for our fiscal 2021, we expect the China plant to actually have some one-time headwinds associated with the start-up, offsetting some of the potential benefits. We're going through the process of getting the appropriate approvals for the OEM business that we have through the joint venture in China. So fiscal 2021 will continue to be relatively neutral to a modest headwind as a result of the China plant. We do expect that plant over the long term to have a return on invested capital in the low double-digit range. We invested— we came in under budget, just under $70 million in terms of the project overall. So longer term, I do expect to see those benefits flow into the China business. And that includes the benefits of volume gains that we expect to see with better control of our supply chain within China.

So you hit that number in 2023, your return on capital target?

I think it's going to be out over— as we look at the plant's production, we'll see the benefits of that build over time in terms of the investment horizon in the longer-term phase. So I'm not going to give specific guidance as it relates to beyond fiscal 2021, but we are well-positioned to see that return on the planned investment we've made over time.

Your next question comes from the line of Simeon Gutman with Morgan Stanley.

Nice results. My first question is the retail channel guidance that you gave for North America, I think you said flat or down 1% slightly. Can you talk about—is that just the typical normal decline that you'd expect? And then can you talk about—is that just from lower usage of oil? Or is that market share? And part of that, Sam, you mentioned, I think, an outlook for stable private label pricing and that I think was driving the way you think about the business for next year. Can you talk about some of the assumptions in there? It sounds like a pretty typical year, but is there anything atypical with some of the inputs?

Yes. Let's first talk about the category, and then we'll talk about Valvoline's plans and expected performance. As far as the category goes, longer term we've seen the category declining at about a 2% to 2.5% clip. Next year, we don't see that dramatically different. We're projecting it to be down maybe 1%, largely because there was weaker performance in the category during that March-April period. But the DIY segment did recover quite quickly from the COVID impact and wasn't as severe as the installer side of the business. So category next year, flat to down 1%. We do expect Valvoline performance to be solid. As we mentioned in the presentation, we had flat DIY volume over the course of fiscal 2020. So we're pleased with that and even a little bit of growth in Q4, so we have good momentum with our plans going into fiscal 2021. One of the most important factors we predicted and discussed was the stabilization of our price gap versus private label into 2021. As we've developed the merchandising plans for 2021 with each of our key accounts, we have a solid plan in place, and we don't see that gap expanding versus private label. In fact, some of the actions we've taken have led to a contraction of that gap versus private label, contributing to the solid performance we've seen. The DIY category has features that are favorable, including continued growth in the synthetic segment. We're focused on growing our share in synthetic with marketing, advertising, consumer promotion and trade promotion. So it represents another solid year in 2021 for the DIY business and overall core North America. We did point out the short-term price/cost lag effect in fiscal 2020 from the dramatic reduction in crude and base oil prices, so we benefited from that. As that turns into a modest headwind, it will impact overall core North America. But nonetheless, when you look at expected performance and what we delivered in Q4 and into next year, we expect very solid performance. Volume overall to be up, and when you compare that profitability to where we were in 2019, it's a nice step up, including the unit margins we pointed out.

Okay. And then my follow-up on the Quick Lubes side. The normalized 6% to 8% growth that you're expecting, is there anything built in for batteries? Where are you with that test? Do you need to push it? Or can you take your time with it since the core business seems to be doing well?

The core business for Quick Lube is strong. We saw a strong recovery starting in June. We restored marketing investment in Q4 and saw excellent performance across regions and good momentum into Q1, with strong October same-store sales. Same-store sales growth has been a combination of transaction and ticket increases, showing that we're taking share and attracting new customers. The battery program will contribute to ticket growth in fiscal 2021. We're close to rolling it out across all company stores by the end of this calendar year, and in calendar year 2021 it will roll across franchise markets. We've been selling batteries for some time but not at the scale we believe is possible with the right testing equipment and supply chain. We've made investments and are seeing results in early markets, doubling battery sales versus before. There's upside as we expand the battery program in 2021 and beyond. Regarding how we continue same-store sales growth while miles driven is softer: first, we're taking share; second, ticket opportunities from non-oil-change revenue, premium mix and pricing power due to strong service delivery. Operational improvement is the number one driver in Quick Lubes profitability. As we add levers—new stores built in recent years—these will begin to contribute in fiscal 2021 and grow in fiscal 2022 and beyond.

Your next question comes from the line of Wendy Nicholson with Citi.

My question has to do with the market share you may have gained over the last few months during the summer because you have a great brand, you had more stores open, maybe some competitors who are more mom-and-pop shops shut down temporarily. Do you think you benefited from that during COVID? And also thinking more on the Quick Lube side: as we go into the fall, this was the great summer of road trips—do you feel part of the thinking in the guidance for the lower first quarter is that everybody just got their oil changed in July, August, September? And so now I don't need to have it done for another six months. Is that credible thinking or off?

Wendy, most of it is right in terms of how we gained market share by keeping stores open during the depth of impact in March-April-May. We worked with franchisees so they made the same decisions. Being open helped us recover faster and kept employees engaged with some higher compensation during that period, which paid off, particularly in Q4. Regarding Q1 and momentum, I want to correct the idea that our Q4 performance was pent-up demand. We're confident in continuing same-store sales and market share growth due to our marketing programs and momentum. The safety aspects of our stay-in-car model resonate with customers today and the continued delivery of a quick, easy, trusted experience. I don't think there was a major benefit from more road trips this summer beyond the recovery in miles driven earlier in the year. Miles driven has leveled off around minus 10%, and in modeling next year we haven't built in further recovery in miles driven—although that would be a nice tailwind. Given ongoing pandemic impacts, we still expect to grow market share even with softer miles driven and capture ticket opportunities as discussed earlier.

Wendy, to be crystal clear, we don't think our performance in Q4 was pent-up demand. We're seeing a really strong start to the new fiscal year and believe the advantages of our model will continue to drive performance going forward.

Fantastic. And then on the M&A environment, thinking that some operators may have had a tougher time during COVID. What are you seeing in terms of the M&A environment? Is it a good time to make more acquisitions versus opening your own stores? How much more bandwidth do you have over the next 12 to 18 months to consolidate the market?

We think the M&A market is very attractive right now. For smaller, less sophisticated operators it has been a tough market. The work we've done to accelerate growth through M&A and build a reputation as a great acquirer gives us continued opportunities in 2021. We've developed relationships and a pipeline, so we're aggressive with our store growth forecast for 2021. Both acquisitions and new builds generate strong ROIC, so both are important levers. Our market share in the overall do-it-for-me marketplace is still quite small, and most of our new customer growth comes from outside the Quick Lube channel—about two-thirds—so building stores increases our share from roughly 4% of the DIFM marketplace to much bigger. The runway for continued store growth through building and acquisitions is large.

And our next question comes from the line of Mike Harrison with Seaport Global Securities.

Sorry. I wanted to revisit the miles-driven discussion. You mentioned it's leveled off in the minus 10% range, yet Quick Lubes showed 8% same-store sales. Should we view that strength as pure market share gain, or are you seeing other changes in how people approach vehicle maintenance even as they drive less?

Overall, it's the strength of our marketing programs, service delivery and growing reputation in our markets. Maintenance behavior varies—some people follow miles, some follow oil-change indicators, some time-based. Those who pay attention to timing have continued maintenance even while driving less. We see busy stores before holidays because customers view us as preventive maintenance, not just oil changes. So a mix of behavior benefits us, plus market share gains as customers find our convenience and trusted service. The model is well-positioned for continued success in 2021 based on consumer preferences.

On Slide 7, the margin leverage in core Quick Lube stores—does that imply Quick Lube EBITDA margin could get back toward the high 20s or better over time as new stores ramp?

Yes, Mike, we do expect to see leverage in our EBITDA margins in Quick Lubes in 2021 and beyond. Some factors moderate pure leverage, including mix of franchise versus company stores—company stores have a slightly lower return on sale than franchise stores—and new store deleverage during the three-year ramp. As we level out with new stores coming on stream in the roughly 50 new stores a year range, we should see that deleveraging impact moderate. But we do expect operating margin leverage in Quick Lubes moving forward.

Your next question comes from the line of Olivia Tong with Bank of America.

Great. I want to start on Quick Lubes. How do you think about company-owned versus franchise versus acquiring, given the plans to expand your store base? How are you thinking about this year versus longer-term plans of about 100 a year?

Olivia, the opportunity for store growth is significant. We will pursue growth in both company and franchise markets. We work closely with franchisees on development where they have strength; many have the capital and desire to grow. In company markets, we're moving aggressively into new markets such as Virginia and Texas and will continue ground-up builds and acquisitions that fit and accelerate growth. Given the large opportunity, we're pulling hard on all levers—franchise development, company ground-ups and acquisitions. Longer term, consolidating smaller mom-and-pop operators will require more work, but our near-term focus is on regional operators and executing the multiple levers to drive growth.

As miles driven eventually improves, can you hold on to the pricing/mix benefit while improving underlying volumes, or is there giveback?

Olivia, we are well-positioned if miles driven improves. Ticket improvements from non-oil-change revenues, including the battery program, the pricing power we have because of our service model, and the premiumization tailwinds mean we should see tailwinds if miles driven recovers. Synthetic penetration still has runway—synthetic is about one-third of Quick Lubes today—so we expect substantial opportunity and do not expect an adverse impact on our pricing power as miles driven recovers.

Your next question comes from the line of Jason English with Goldman Sachs.

This is Cody on for Jason. I wanted to talk about International. Your guidance calls for significant top-line growth but moderating profit growth due to channel development and brand investments. Historically volumes grew only modestly—can you remind us of the growth opportunity in International, especially as the China plant comes on? And why invest those dollars there instead of accelerating Quick Lubes?

Looking at International, over the last 10 years we've had nice growth and built a solid business with meaningful contributions from each region. Growth slowed in '18 and '19, but opportunities remain significant. We've developed distribution, supply chain and capabilities and are supplementing channel development with brand investments. We have momentum going into fiscal 2021 because of our team and focus in key regions. China is particularly important; it's now the world's largest lubricants market when you combine passenger car and heavy duty. Valvoline is committed to growing there. We have a strong team and strengths with Cummins on heavy duty, and on passenger cars we've been making inroads. Having a plant there benefits us similar to how it benefited us in India: strengthened the business, helped OEM relationships, improved service and margins. The investment is meaningful and will be a headwind next year but longer term will deliver returns. This investment doesn't take away from the speed of Quick Lube growth. We're not capital constrained; we are aggressive on building stores and M&A simultaneously. International isn't highly capital intensive generally; the China plant was a unique investment given the size of that market opportunity. Going forward we don't plan major capital investments in International; instead, investments will be SG&A to grow channel and brand. We believe International can deliver top-line growth in the high single digits and bottom-line growth close to that.

Cody, I would also remind you that China surpassed the U.S. as the #1 lubricants market in the world last year. We think it's important to have a meaningful position as that market moves to higher premium technology products with improving emission standards and regulations. We believe there's a meaningful profit opportunity and the supply chain investment will support our expanding growth there.

I'd add we're also piloting retail stores in China now, which could be a nice long-term growth opportunity.

Quick housekeeping—your EBITDA guidance of about 12% growth, but cash flow from operations looks roughly flat. What's driving the delta?

The largest delta is the increase in cash taxes, which is going up by more than $40 million. In fiscal 2020, we benefited from the borrower-to-fund transaction we did in 2018 that allowed use of foreign tax credits and the NOL, keeping cash taxes down. We've largely used up those deferred tax assets, so in 2021 we're back to more normal cash tax payments, which is the primary driver of the cash flow difference.

Your next question comes from the line of Chris Shaw with Monness Crespi.

Just another market share question. I assume some of the third-quarter market share gains were from dealers being closed. Do you have any sense that customers you gained in Q3 are staying? I know it's early, but any sense of stickiness?

It's a bit early to fully read retention of new customers gained in Q3, but trends are encouraging. As competing installer outlets have reopened, our trends have remained very solid and consistent.

Historically we have had very strong retention rates: well in excess of 50% after the first visit and over 70% after the second visit. Given historical retention plus the stay-in-car service model and the COVID environment, we expect customer market share gains and good retention. I'm optimistic we will retain those customers.

Do you have any sense of the financial health of the industry, maybe some smaller players? Was financial stress involved in recent acquisitions of small retail chains?

The acquisitions we've closed in October have been from healthy operators with good models. We see more opportunities, especially among very small mom-and-pop operators, but the deals we've announced and completed recently have come from financially healthy operators.

That said, we do expect some weaker operators that have struggled could become attractive acquisitions and more interested in selling. When we evaluate acquisitions, we run our real estate model to understand location potential. We've had good success acquiring stores with upside in transactions and ticket by adding the Valvoline brand, marketing programs and service execution.

And our final question comes from the line of Laurence Alexander with Jefferies.

Two quick questions. First, can you give a sense for the longer-term opportunity to accelerate growth in China through partnerships or acquisitions? If you decided to deploy capital, what kind of cadence could be feasible? Second, for Quick Lubes longer-term, why shouldn't the base case for the number of new stores accelerate as you get scale and free cash flow improves—should we be thinking about 75 to 100 new stores in 2025 rather than 50-plus?

On China, we have multiple avenues for growth. We're focused on strengthening both heavy-duty and passenger car businesses. For passenger cars, we're investing in brand and channel development and expect the plant and OEM relationships to help. Partnerships are important—our retail store pilot in China includes a local partner bringing market expertise. Early results are encouraging; the capital investment for these retail pilots is much lower than in the U.S. We're learning how to approach that market, which we see as a high-quality alternative to the dealership. Car parc age is lower in China—roughly about six years versus 11 to 12 years in the U.S.—so many relatively new car owners will look for convenient, cost-effective alternatives to the dealership. We're investing to unlock that opportunity. For the U.S. Quick Lube growth and ground-ups: when we separated from Ashland four years ago, we didn't have infrastructure to build new stores, but we've invested and built capabilities and teams that have ramped up store growth, and we expect to deliver 50 new stores next year. Ground-ups are an 18-month cycle, so building and maintaining the pipeline is key. The work we're doing prepares us for fiscal 2022 growth, and we'll look to accelerate from 50 to a higher number as we validate capabilities and results. We're not yet ready to commit to a specific higher number, but as capabilities and success grow, we will look to expand. I'm pleased with progress in store development, corporate development and franchise development teams as we execute on this opportunity. All right. Well, it sounds like that is the end of the questions. Let me just say again, what an incredible year it has been for the Valvoline business and team. Couldn't be more pleased with how they responded, and we're really well-positioned. As I mentioned, we see fiscal 2021 as a key year to show the business's growth profile is stronger than ever. We see an accelerating phase of growth provided in our guidance and feel very confident even in the face of COVID-19 challenges. We hope that as we move beyond the pandemic it creates tailwinds for us. Appreciate everyone's interest and a very bright future for Valvoline into 2021 and beyond. Thank you.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.