Even during a down period for the markets, Driven Brands has gone against the grain, climbing to $16.60. Its shares have yielded a 17.4% return over the last six months, beating the S&P 500 by 18.4%. This performance may have investors wondering how to approach the situation.
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Despite the momentum, we're cautious about Driven Brands. Here are three reasons why we avoid DRVN and a stock we'd rather own.
Why Is Driven Brands Not Exciting?
With a diverse portfolio of well-known brands including CARSTAR, Maaco, Meineke, and Take 5 Oil Change, Driven Brands (NASDAQ:DRVN) operates North America's largest automotive services company with approximately 5,000 locations offering maintenance, car wash, paint, collision, and glass repair services.
1. Core Business Falling Behind as Demand Plateaus
We can better understand Industrial & Environmental Services companies by analyzing their organic revenue. This metric gives visibility into Driven Brands’s core business because it excludes one-time events such as mergers, acquisitions, and divestitures along with foreign currency fluctuations - non-fundamental factors that can manipulate the income statement.
Over the last two years, Driven Brands failed to grow its organic revenue. This performance slightly lagged the sector and implies it may need to improve its products, pricing, or go-to-market strategy. It also suggests Driven Brands might have to lean into acquisitions to accelerate growth, which isn’t ideal because M&A can be expensive and risky (integrations often disrupt focus).
2. New Investments Fail to Bear Fruit as ROIC Declines
ROIC, or return on invested capital, is a metric showing how much operating profit a company generates relative to the money it has raised (debt and equity).
We like to invest in businesses with high returns, but the trend in a company’s ROIC is what often surprises the market and moves the stock price. Unfortunately, Driven Brands’s ROIC has decreased significantly over the last few years. Paired with its already low returns, these declines suggest its profitable growth opportunities are few and far between.
3. Short Cash Runway Exposes Shareholders to Potential Dilution
As long-term investors, the risk we care about most is the permanent loss of capital, which can happen when a company goes bankrupt or raises money from a disadvantaged position. This is separate from short-term stock price volatility, something we are much less bothered by.
Driven Brands burned through $44.2 million of cash over the last year, and its $4.00 billion of debt exceeds the $170.3 million of cash on its balance sheet. This is a deal breaker for us because indebted loss-making companies spell trouble.
Unless the Driven Brands’s fundamentals change quickly, it might find itself in a position where it must raise capital from investors to continue operating. Whether that would be favorable is unclear because dilution is a headwind for shareholder returns.
We remain cautious of Driven Brands until it generates consistent free cash flow or any of its announced financing plans materialize on its balance sheet.
Final Judgment
Driven Brands isn’t a terrible business, but it isn’t one of our picks. With its shares beating the market recently, the stock trades at 13.3× forward price-to-earnings (or $16.60 per share). Beauty is in the eye of the beholder, but we don’t really see a big opportunity at the moment. We're fairly confident there are better stocks to buy right now. We’d suggest looking at one of Charlie Munger’s all-time favorite businesses.
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