Episode 2: With Financial Markets Expert Chris Jenks
About the Episode:
Are you wondering about the potential impact of rising inflation and changing global dynamics on your car wash? Learn practical strategies you can deploy now to protect your business in an inflationary environment amidst global uncertainty.
Listen to Chris Jenks share his perspective on what the latest economic changes mean for car wash owners. Chris and Lanese discuss specific actions you can take today to successfully navigate these challenging times.
More about Chris Jenks:
Chris joined Amplify Car Wash Advisors as chief operating officer in 2022 bringing a strong background in investment management. With more than 16 years of experience in quantitative investing, he served as director of quantitative equities at BMO Global Asset Management where he was part of an investment team responsible for more than $16 billion in assets under management. While there, Chris developed an interest in the car wash industry due to the emerging applications of data and analytics. Chris is also owner of Driven Car Wash, a growing express car wash chain in the Chicagoland area. Prior to BMO, Chris served as director of research at Embree Financial Group and as vice president and senior investment strategist at Northern Trust Global Investments. Chris holds a B.S. in Finance and Marketing from DePaul University and is also a Chartered Financial Analyst (CFA®) charterholder and a member of the CFA Institute and the CFA Society of Chicago.
Check out the full transcript of Lanese’s interview with Chris below:
Hi, I’m Lanese Barnett, Vice President of Business Development at Amplify Car Wash Advisors and your host of Car Wash M&A, The Podcast. Here we’ll take a deep dive into the current mergers and acquisitions activity of the car wash industry with a goal of keeping carwash owners informed on where the market is today, and where it’s going tomorrow, so that you can make informed decisions about your business. We’ll help you answer the question: Should I sell my carwash now? Or should I enter growth mode and really scale my operation? Each month I’ll speak with industry experts who will share practical advice on how to sell or scale your car wash. While the industry is undoubtably changing, what remains constant is the need for solid information so you can evaluate where you are and chart the course for the future of your business.
Thank you all for joining us on episode two of Car Wash M&A, The Podcast. I’m here today with Chris Jenks. He is the chief operating officer of Amplify Car Wash Advisors. And a little bit of background on Chris. He is a chartered financial analyst. He has 16 years of institutional management. He’s held positions as an investment strategist, Director of investment research, and before being called upon by the car wash industry, was part of an investment team that was responsible for $16 billion of global assets under management. So Chris, it’s fair to say that you have some experience in both the investment world and then also we forgot to mention your car wash side of it, but you are also an owner of a car wash chain as well. So, you’ve gotten your hands dirty and you can you can have some street cred with that as well!
That is correct. Yes, I think car washing is certainly more exciting, but I certainly love being able to bridge the gap between financial markets and what it means for car washers.
Great! And that’s exactly what we’re here to talk about today is we want to take some time to dive into what’s going on globally and what that means for the car wash industry specifically. At the time of this recording, we’re in mid-March, and we’re seeing so many things that are changing. And that’s really caused us to pivot what our strategy or what our plan was for recording these episodes, and kind of take this pause to cover some of the economic impacts of global price changes and fuel prices and what’s going on in Ukraine and how that could potentially impact us and how that is impacting us. As we get started, if you could just kind of give us an overview of what your opinion is on where we are as the US economy on a macro level and what current changes have affected us as the United States.
Yeah, absolutely. So, you know, it’s certainly a dynamic environment here, as we really dissect the macro environment and you know, definitely want to start with the positives first. You know, at the end of the day, the US continues to recover from the negative economic effects of the COVID 19 pandemic.
Thankfully, yes. Now if we’re to look at fourth quarter gross domestic product, in the fourth quarter alone, GDP jumped about 7%. Unemployment levels, as of the February read, came in at about 3.8%. So not too far away from pre pandemic levels, which were about three and a half percent. So overall, you know, very strong footing. We continue to see a robust recovery of the economy following COVID-19. That being said, you know, we’re starting to see economists revise their forward-looking outlook for the US economy downward. So tapered to some extent… Most economists are coming in somewhere in the ballpark between 2 to 3% full year GDP growth for the calendar year 2022. And a large reason for that, as you alluded to, Lanese, was inflation. It is no surprise. Inflation is a huge headline in today’s world and a big risk to the economy. If we’re to look at the most recent CPI measurement, which came out towards the end of February, inflation over the 12-month period went up about 7.9% And that actually represents the largest reading in over 40 years. You have to go back to July 1981. Yeah, so a big jump there. This is largely driven by increased energy prices. Energy as a category is up about 25% year over year. And if we’re to really drill down within the energy bucket, to no surprise, it’s fuel and gasoline. Fuel prices are up more than 40% year over year, but even beyond energy and fuel, you know, everywhere we look, it’s beyond the gas pump. Things are more expensive: clothing is up 6%, food is up 8%, new automobiles are up 12%. So, again, by and large, the big theme as of late Is in fact inflation. And that certainly tapering expectations for the continuation of the economic recovery here.
Fuel was already on the rise prior to this invasion of Ukraine, which is impacting the global oil supply, and then what we see at the pump that is causing that to go up, so it was already ticking up. But now we’ve seen this further tick, which makes it feel so much more tangible. And it’s so much more noticeable that that’s making a big impact. And so I think some folks might think, “Well, I mean, we can produce our own oil. We don’t even get that much from Russia!” So, why is that having such an impact here? And what we’re seeing at our local station, so what is that? Why do we have that impact?
Yeah, really good question. So the CPI numbers that I just recited here…
Okay, Chris, so you referenced CPI. Could you just give us a quick explanation of what that means?
Absolutely. So a CPI stands for the consumer price index. And this is something that’s provided by the US Bureau of Labor Statistics. And essentially, what this does is it measures the change in price that consumers pay for a basket of goods and services. So it’s just a way to make the measurement of inflation a bit more tangible and transparent.
So like, okay, eggs cost this much different and clothes or whatever…
Housing, automobiles, you know, food, beverage and tobacco, you name it… That’s correct. It’s just it’s a composite measurement of the aggregate costs and changing costs for a basket of goods.
This index, does it change often? Is this like always a variable, or are there bigger ticks?
There are monthly readings in this index. Two things to look at would be the month over month change, but the most common measurement would just be a change year after a year. And in this case, again, your CPI increased by 7.9% as of February, which represents the largest 12 month increase since 1981.
Okay, thank you for diving into that a little bit deeper, so we can know what to look for.
Yep. So the inflation numbers that I just recited, were through the end of February. So that, of course, does not account for the Russian invasion of Ukraine. Why is this important? Well, Lanese, as you said, Russia is a significant producer of global oil. In fact, they produce roughly 10% of the global oil supply. So, as we look at what happened to crude oil prices, since the invasion, they skyrocketed. We saw oil prices top about $120 a barrel. Before the invasion, they were in the low 90s. Now, this has moderated to some extent. Today, you know, we’re looking about $100 a barrel, but nonetheless, a 10% increase in oil prices since the invasion. So, you know, as we talk about inflation through February, I certainly expect that those numbers are… may look even worse as we get the March read and CPI inflation here, because it does not account for that crunch and supply given the invasion and sanctions on the use of Russian oil. Now, you asked the question: why does that matter? Russian oil accounts for about 10% of the global supply. So, you really need to think about from a global context, right? If we look at it from the US microcosm, yes, the US only gets about 3% of our oil from Russia. That being said, globally, it’s a much bigger deal. If we’re to use Europe, for example, our European counterparts receive about 60% of their oil from Russia. So if they cut off using Russian oil, that’s 60% that has got to be backfilled from elsewhere. So, you can imagine from a global context that this is pretty disruptive. Again, we saw a surge in oil prices. Fortunately, over the last couple of weeks, we’ve had other countries within OPEC, notably, the United Arab Emirates, and Saudi Arabia, commit their excess capacity to increasing production. So, hopefully that softens some of the blow, but oil prices are definitely higher. We’re seeing at the gas pump today. And by the time this podcast is recorded, we’ll see where oil prices are. They’re pretty dynamic right now.
Right. This is a very fluid situation, and especially coming out of what seems like it’s been forever that we’ve been going through COVID and then emerging out of it. And then there’s a, you know, there’s a ray of sunshine. And then there’s something new that’s another global impact. There’s some positives from that, which we’ll kind of get into later. But some of those things are kind of being able to pivot more quickly, and the agility of businesses to react and to re-strategize based on new factors that come up that are outside of their control. That is one thing that we’ve been forced to learn and exercise that in the last couple of years.
You have to be nimble.
Yes. So, inflation: what can be done to control inflation? Or what can we do strategy wise, as far as… It’s going to happen. It is happening, but what are some measures that can be done to have an impact on that?
Yeah, so the most effective tool to combating inflation is through monetary policy. So specifically, the Federal Reserve adjusting interest rates to cool down the economy and essentially combat inflation. You have to think about, you know, what causes inflation at the end of the day? And it’s usually access to the money supply. So, what do you do to control that? You reduce the money supply, the supply of money that’s out in the system. The Federal Reserve, by adjusting the Fed target rate and bringing interest rates higher, that’s certainly an effective way. And if you were to think about today’s environment, what’s causing inflation? You know, it’s really a mosaic of different things, right? You have a global supply chain issue, which is putting a bottleneck on the actual supply of goods, you have surging demand following a recovering economy from COVID-19. And you really have the effects of about $2 trillion in stimulus money really coming into play here. And I know, a stimulus from COVID… We’re a couple of years removed from that, but you have to think, you know, there’s a little bit of a lag there between when that stimulus money is put to work. And by the time it actually trickles down throughout the economy. And we’re starting to see the effects of this. So here we are today, in an inflationary environment. As mentioned, you know, the one tool that can be used to combat this would be changes in monetary policy, specifically rising interest rates. And as of yesterday, the Federal Reserve actually increased their target rate by .25% for the first time since 2018.
And that increase is projected to be a steady continual increase for the foreseeable future, or at least throughout the rest of the year.
Absolutely. The CME Group actually has a really interesting tool, that’s available on the website, that’s called the FedWatch tool. And essentially, what they do is they look at the futures market to figure out okay, what’s being priced in here? And what they could do is they could put implied probabilities on the future of rate hikes. As of right now, as of yesterday’s hike, what the markets are telling us is that there’s about a 90% probability that interest rates will go up by at least other 1.5% throughout the calendar year of 2022. So you hit it right in the head! I think, you know, this is just the start. I think if we were to look going forward, and what markets are telling us today, there’s a high probability that rate hikes will continue with each of the Federal Reserve meetings to come. In fact, if you’re looking all the way through July of next year, in 2023, there’s a 100% probability of an increase in every meeting from here on out to the end of July of 2023. So I certainly think that’s in the cards for the future.
Not that that’s good or bad, but at least we haven’t had the interest rates rise as of yet. So now we’re in essence making up a little bit for years of stagnant interest rates, right?
Yes, I mean, what we have to keep in mind is that what we’re experiencing now… This is not the exception, right? Many years of accommodative policy following really the effects of the financial crisis back in ’08, we never really were able to get back to the path of normalcy here. So you hit it right on the head. I think, you know, there’s certainly some shock, just based on increases in interest rates. Because we’ve been so accustomed over the last decade plus of low rates… It’s important to keep in mind that that was the exception, right? We’re now going back to the path of normalcy.
It’s crazy because with so many things in life, you get used to where you are right now. And it’s hard to see those cycles that do ebb and flow, and they have this circle. But when you’re in the space that you’re in right now, you think, “Okay, well, it’s just going to stay this way forever” when that’s really not the case in most things in life.
We’ve talked a little bit or about what inflation looks like and what rising interest rates look like for the US economy. But what does that mean for carwash owners specifically? And what can they expect? And then what kind of tools do we have specifically related to them?
The most direct impact here obviously is with consumer behavior, right? How much is inflation going to spook the consumer? And, you know, if we’re to look at the University of Michigan Consumer Sentiment Survey… At the University of Michigan, they survey over 500 participants from different geographical regions in the United States and they ask them the questions along the lines of their personal finances, as well as their outlook for the economy over the short and long term periods. And what the most recent survey showed us is that consumer sentiment is at its lowest level since November of 2011. So shortly after the S&P downgrade of US Treasuries. So, all of the macro concerns we’ve talked about between inflation and rising gas prices, the war in Ukraine… This is definitely weighing on the consumer. So the question now is how discretionary is carwashing, right? Over the last decade, we have seen consumers embrace the car wash model, specifically the Express car wash model. By and large, consumers are using professional car washing services more now than ever, and the Express model has become, you know, a convenient solution for consumers where it’s now ingrained in their daily activities. As you mentioned, Lanese, we have car wash operations here in Chicago, and we have some customers that are membership customers. I mean, they’re on our site daily. The question is now, are they going to stop the car washing? Or will they maybe stop buying a $3 coffee at Starbucks? You know, the last litmus test was COVID, and car washing was resilient during the COVID. So I think, you know, we’re learning in real time how discretionary is car washing? I think, you know, a good indication is what’s Wall Street telling us? We now have some publicly traded companies out there — MIster Carwash, notably — and we’ve actually seen some positive revisions from sell side analysts on Wall Street, stating that the concerns over inflation and fuel prices may be overdone, and they’ve actually changed their ratings from the hold to a buy. So a lot of considerations to be thinking around here. But generally speaking, it’s definitely impacting the consumer. It’s time now to get strategic if you’re an operator.
But that news that came out today about the confidence, and specifically that was about Mister Carwash, but that’s such good news. And it’s such… it’s encouraging not to have all bad news and to see that just like we emerged through COVID, and are still emerging through it, that there were a lot of silver linings to that with the exposure of the carwash industry as far as answering that question: how discretionary is it? And how resilient is it? And we’ve been fortunate as an industry in many ways that we’ve been much more resilient than other sectors of business that were hit so much harder. And I think that, you know, hopefully, as an industry, we can keep using that information and how to best serve our customers to keep this momentum going. And if they have a demand and they have a desire for it, then we will need it as best we can. And again, with this ability to shift strategies or pivot to accommodate for things that are outside of our control.
Yeah, I think you hit it on the head, right? This is not the time to be complacent. We do have some headwinds to consider here, especially as it’s… You know, it’s not just the consumer, right? If you’re running a car wash today, you know, your margins have changed quite a bit because the cost structure is evolving. You know, you have input costs rising due to inflation. So, a good example, if you were to look silicone prices, right? Silicone last October surged 300%. As we all know, in car washing, silicone is a very predominant ingredient in most tire shines and tire dressings. We have wage inflation, right? Wage inflation is up on average 5%. So if you’re an operator, your cost structure is going up quite a bit. I think the knee jerk reaction in a rising cost environment is just passing it back to the consumer and increasing your prices. But as mentioned, the consumer is certainly feeling the pain here a little bit as well through inflation, and everything being more expensive. So one thing we’ve heard or we’ve seen a lot of here lately is car wash chains and operators increasing their prices to accommodate for their change in cost structures. You have to be a little more strategic than that, right? I think strategic price changes may make sense. But you have to really understand your local market if you’re going to do that. Specifically, know your level of competition. If you are in a highly competitive market with other alternatives for car wash tunnels, you know, you might find yourself in a game of chicken with a local competition. Also, you have to consider your local demographic, right? If you are operating in areas where there’s less discretionary income, a price chain may not be prudent in the current environment, because again, the consumer is feeling the pain as well as inflation at about 8%.
And it’s not saying that you shouldn’t consider price changes. But what we’re suggesting is that you should really consider all of these factors before making a knee jerk decision or reaction based on rising input costs and rising costs on the operator side. Because, as you mentioned, you know, consumers, while we’re seeing that car washing is less discretionary than other things, say going to buy a cup of coffee at Starbucks, it’s still discretionary, like it still falls into that category. And we have to be sensitive that these price increases in such a sensitive time in their world, in their pocketbook, as well that we don’t want to drive them away for that. But there are other things that car wash operators could consider changing or re-evaluating within their own operations that could offset some of those rising costs. And that’s one of the things that I wanted to talk about with you: what are some options for them to offset this?
Great question. Yeah, there’s a lot more than just increasing revenues by passing back price changes to your consumer, This is a good time, in an inflationary environment, as I mentioned, one thing that usually accompanies inflation is rising interest rates. Now’s a really good time to be looking at your debt for your company. And specifically using this as an opportunity to potentially refinance some of your shorter-term variable rate debt and lock in longer term debt at a lower interest rate.
Especially if we know that the interest rates are going to continue to rise! We see there is a 100% probability of rates increasing over the next year, continually, so we know it’s happening.
Absolutely. So again, now’s a good time to understand kind of what is your debt look like? Was your cost of capital look like? Intentionally restructuring short term variable rate debt to longer term fixed rate at the current lower rates. And that definitely be one thing you could do here. You know, other things to consider: you know, locking in long term arrangements with your vendors. You know, that’s certainly something you could take advantage of today, if you expect costs in general to continue to rise. Lock in long term contracts with your vendors that could potentially keep you at a lower rate today for a longer period of time. And remove that exposure to what could be variable pricing in the future.
And I really like that suggestion, because it’s also relationship building with your vendors, because you’re also making a commitment to them that, “Hey, I know that you’re going through the same thing that I am as a business owner, and I am committing my business to you, and we’re just going to make this agreement that this is the best way that could be a win win for both of us.”
We all know the adage of bird in the hand is worth two in the bush, and this is one of those situations here where your vendor could lock in a long-term cash flow stream, and you could lock In some sort of certainty in your price structure.
Right. On the debt restructuring, that’s something that tour company, that Amplify Car Wash Advisors, on our capital advisory side, that is a service that we provide, and that we can help coach and guide people through how to do that. And, you know, what steps to take and what your options are.
Yeah, we have seen a significant increase in the demand for restructuring Debt Solutions via our capital advisory business. Absolutely. One other thing to consider here, too, as we’re looking at potential tools for operators in this rising cost environment. We have been fortunate that we’ve just seen a massive tech boom over the last five years. And this is something that really extends across all industries. But in car washing, specifically, there’s some very neat, early-stage innovative solutions utilizing technology. And generally speaking, this is a great time to start looking at some of these newer technologies for the purposes of increasing your efficiencies, protecting your margins, and essentially kind of reshaping the workflow, and potentially reallocating some of that more human element of the workflow, and utilizing newer forms of technology innovation automation, to potentially free up some of that labor expense and increase efficiencies in your operations.
Absolutely. The carwash industry is so amazing because there are so many different areas that are involved between chemistry and mechanics and electrical. But with that, I feel like there has been a slow growth in technology in certain areas like the ability to sell online and e-commerce, how to manage monthly plans, how to send gift cards electronically, or using an app. And it’s really cool going to either the regional or national carwash shows. And as I walk around the floor, I see so many new companies that are offering different services to fill this gap that’s been there because the challenge for car wash owners, in my experience, has been that are not tech gurus, and that they’re not going to go out and write code for software. And hiring someone to do that specifically for your own business can be tremendously expensive. So now there are these new vendors and providers that offer services that you can subscribe to, or that you can use to fill that void and meet the consumers’ growing need for. They want it fast, and they want to speak to someone right away. If they’re making a decision about buying and they’re already on your website and they’re on that page, you want to be able to process that. And in the past, it’s been okay, we’ll come into the location, you can go up to the cashier, you can buy a gift card, then you can mail it to your dad for Father’s Day, or whatever it may be. That is a horribly antiquated way to do that when we’re missing so much opportunity to reach customers more quickly.
That is a fantastic example of how technology could be used, right? Really focusing on different tools that take the point of sale away from the lot into the e-commerce space. And you think about that… Your example of purchasing a gift card. Now I have first-hand witnessed the exchange on site of what it’s like for a customer talking to a manager, an associate, trying to load a gift card. That’s time that could be spent elsewhere in your operations, right? If you were to have a sound solution electronically to take your customer base to the electronic side of things. That’s one really great tangible example. Something else, too, which we didn’t talk about in this environment, something you think about from the operator perspective, and you kind of hit on it. But if you’re a membership base operation, where you have a significant base of unlimited plan members, now’s a really good time to be a little bit more proactive, have retention based promotions and incentives for your members to keep them in the door during this rising costs environment. Also making sure that you have your staff trained up.
Right! So important.
Oh, absolutely. If you have you know, let’s call it varying prices and packages for your memberships, make sure your staff is trained in the art of down selling, right? So maybe you have a member that’s currently paying $40 a month for the top plan. Do you want to see that member go out the door completely? Or could you train your staff and give them some tools and techniques to down sell them into a lower cost plan to retain that member. So this is no time to be sitting on your hands! Be proactive, give the incentive to your customers to keep car washing their vehicles, and specifically have some strategies in place to protect the golden goose, which is your unlimited plan base.
Right. And with that training, so… As we’ve talked about automations and streamlining and taking away some of the human element, it does give an opportunity to look at your staff, and perhaps as you’re automating certain aspects of your business, you can put more emphasis and look for higher performing humans that you have on there that are customer facing that do a great job at building those relationships with the customer, so that you do keep your unlimited plan members, that you do gain new members, that you don’t lose them, and that you still have the human element where it counts the most. So maybe there are areas where it’s less important but having some interaction and the ability to communicate directly makes a huge difference with customer loyalty because…
If it’s part of their daily habits and their patterns, but especially if they have some sort of connection and some sort of relationship, then they’re much more likely to remain loyal to you over somebody else, regardless of changes in competition or other factors.
100%. I think as we talk about the explosion and the boom in technology, especially in the sense of how it relates to automation and the use of artificial intelligence and big data… I never really foresee this as a machine replacing the human element, right? I think it’s more of a machine plus human interaction, and you hit it right on the head. Using those automations, what it allows you to do is allocate that human work stream that workflow, not from the mundane task of diagnostics, or what have you, but a more valued activity such as fostering good relationships with your customer base. I think 100% even, you know, aside from this inflationary environment, to the benefits, you know, at this exact moment… Bigger picture — definitely utilize some emerging technology out there because, I promise you, what you’re going to find is you have more fruitful interactions with your customers because your employees will be able to better allocate their time to those higher value activities.
And, you know what this also does is it poises these operations for scalability, because the more that you have the standardization of your workflow and your operations, and you have the training in place for the staff to sell the monthly plans or have that training part of it, then you can repeat that because now you have a playbook for success, and you’re limiting the variables that are outside of your control. So right now, we’re in an environment where labor is very expensive. So, if your model is just put a bunch of people on the clock and hope that they do okay, more bodies is better, obviously, we went through COVID, and we experienced that that’s not the most fruitful route, but it’s really forced us to look at these different areas. And you’re right, it doesn’t mean that we’re trying to say that car washing is completely impersonal and automated, but it’s just taking those personal connection opportunities and maximizing them and maximizing technology and automation and therefore replicability and scalability.
So we’ve given some good, hopefully helpful tools for carwash owners of what they can do in light of rising fuel prices, rising interest rates, inflation, the impacts that we’re seeing even stateside from the Russian invasion of Ukraine, hopefully these give some, again, some tangible tools for that. I would also like to talk about a little bit, from our vantage point at Amplify Car Wash Advisors, what does all of this information mean for the M&A cycle and M&A activity of the carwash base right now?
Yeah, so first and foremost, I mean, this is still an industry in growth mode, right? That’s not changing anytime soon. We have, you know, at the end of the day, a very fragmented market, and we have growing acceptance by consumers. So there’s certainly a massive gap as it just relates to the supply of carwash inventory. That’s still going to persist. However, in the shorter term, you know, definitely foresee a future where the economics are changing in real time on the buy versus build debate. So that path to growth may may change slightly in this this environment. You know, depending on the market that you’re in, you know, cost of new builds are up anywhere, let’s call it 10 to 20%. So that being said, that path to growth…
That’s a lot!
That’s a lot, yeah.
And they’ve already been rising over the last two years. We’ve seen the cost to build a new site for an Express exterior significantly higher than three plus years ago. So on top of that… And I think that this is an interesting point for showing some of the the shifts in strategy for either larger groups, or even for multi-site operators that are maybe at three locations and looking at going to four or five or six. In our estimation, we were seeing or predicting a shift more to Greenfield development. At some point, you know, it would become cheaper to build than to buy! And this is kind of shifting that outlook to a certain degree because of other factors that are continuing to compound that price, too, or that cost to build. That could be something to continue to think about. Now, while that’s great, there’s also the flip side of this that with rising interest rates, that there is an impact on valuations. Right?
Absolutely. Before valuations, the other thing I want to highlight here is, on the buy versus build debate, is it essentially the costs but also the time. I mentioned that one of the big drivers of this inflationary environment we’re in today is challenges in the supply chain. And with those challenges supply chain, I feel like almost everything, as it relates to materials, you know, equipment, your PLS, everything is delayed today.
So now you have the challenges of cost, but you also have the challenges of time. So, you know, certainly I foresee shifting motivations and incentives and the economics changing in the buy versus build debate. Now your question of valuations. That’s a really interesting one. How does this environment impact valuations? The most direct impact is going to be by rising interest rates. Now why is that? Interest rates are very important component in determining valuations. One of the most widely accepted valuation models is known as a DCF valuation model, and DCF stands for discounted cash flows. And the reason for this is if you’re buying a car wash business, essentially what you’re doing is you’re buying a future pattern of cash flows. You’re buying future cash flow rates.
So, what you have to do is you discount those future cash flows back to the present value. That valuation depends on the discount rate. That discount rate is largely influenced by interest rates, and there’s an inverse relationship there, right? So, if interest rates increase, valuations go down, because you’re discounting those future cash flows at a greater rate. Conversely, if interest rates are lower, those valuations go up. So that being said, you have inflation, inflation leads to higher interest rates, interest rates have an adverse impact on current valuations, specifically, as you’re looking at more from a discounted cash flow valuation model. So, that’s one way. That being said…
That sounds bad.
That sounds bad, but I’m going to put a little bit of a positive on this, okay? As we talk about interest rates and the increase interest rates, you have to think about what this means along the entirety of the yield curve. So the yield curve is just a representation of the relative difference in interest rates along different maturities. So…
Over a span of time.
Over a span of time. That’s correct. So one thing we’ve seen lately, as we talk about the yield curve, shorter term rates are more directly influenced by the Federal Reserve. As we look at longer term rates, longer term rates are more influenced by the basic principles of supply and demand, as well as expectations of future economic growth. And what we see in the current environment is that interest rates that have shorter maturities have increased by a much larger degree compared to longer term rates. And longer-term rates are far more relevant in determining valuations, because typically investors hold investors for longer periods of time. So, you use longer term rates, such as 10-year interest rates. Now, if we were to do a quick comparison year over year, if we were to look at changes in two-year treasury yields, two-year treasury yields have increased by approximately 1.8% over the last one year. So, that’s a pretty significant increase. Now, if we were to look at 10-year treasury yields, they’ve only increased by about .5%, so not as much of a change. And what that is known as is that’s called the flattening of the yield curve, right? The reason for that is you have the Fed increasing short term rates to aggressively combat inflation. Yet, if you think about the long-term prospects for future economic growth, those rises in interest rates tied to money supply, we’ve seen long-term growth expectations moderate quite a bit. So instead of yield curve steepening, that yield curve is flattened. So, where I’m going with this, is that that ten year, or thereabouts, is a little bit more critical in determining valuations. We haven’t seen the pop in interest rates in longer duration bond yields, that we’ve seen the shorter term. So while interest rates are theoretically a negative, I think you have to think about what that means along the spectrum of the yield curve, and you’re not seeing as much impact in valuations in today’s market.
And again, for these institutional investors and people that are very interested in the car wash space, that flattening of the yield curve matters, and it matters to owners who are considering if now is a good time to potentially sell their business that the impact on valuations is less…
Less significant than it could be or that the kind of that immediate reaction, when you hear rising interest rates and inflation, it’s not just that valuations are going straight down. It’s that this does have an effect on them, but it has less of an effect than may initially be thought of.
That’s correct. I think, you know, from a valuation perspective, you know, we’re personally seeing valuations go the opposite direction. We’re still seeing very attractive multiples in some of these really attractive deals. And I think a lot of it is, again, because the change in rates is not uniform across all spectrums of the yield curve. We’re seeing REITs increase more in that short end. So it’s offering some immunity to valuations at the current moment.
And the other thing that you mentioned earlier that the market is still fragmented, and that there’s still a lot of money that’s out there, that needs to be deployed somewhere. So, there’s a lot of dry powder available that these investment institutions need to put that money somewhere. And all businesses are affected by inflation or rising interest rates. But the silver lining for the carwash industry is that it’s shown through the experience of COVID, that it’s more resilient than other businesses. So it’s still an attractive investment opportunity.
Absolutely. What we’re dealing with here is a short-term phenomenon at the moment, right? The overarching theme here is you have to be nimble, you have to be strategic in how you navigate this. But as we look at the long-term dynamics of this industry, none of that is changing, right? There’s still a long-term incentive for people to buy in this industry. Shorter term one thing we didn’t address is the the geopolitical uncertainty and inflation — it’s causing concern from some of the larger institutional buyers, right? That’s no surprise. They have very robust risk management policy. So if you think about this for a buyer lens, you know there certainly buyers out there that are a little bit more hesitant to buy in anything today, for that matter just given some the uncertainty. Uncertainty is always a bad thing. So I don’t want to sit here and just be completely optimistic because there’s definitely concern there. But, to your point, as we look at this industry for the long term, it is still very ripe for growth. We have, to your point, fragmented market, growing consumer acceptance. And a lot of those financial institutional buyers that have been driving a lot of growth in this space, they still have an abundance of dry powder sitting on the sidelines that need to be deployed, and those dynamics will not change.
And thankfully, with the consumer acceptance that’s largely tied to the unlimited plans. And that’s what’s also very attractive is that reoccurring revenue stream, if those continue to grow, and that’s the real opportunity as well for maintaining and protecting those margins, amongst the other things that we talked about.
100%. That’s a key component of valuations too, right? If you think about what drives valuations, I talked about interest rates. And, you know, that’s largely because that influences the cost of capital of the company. You know, another key determining factor in valuations would be the stability in cash flows. The more stable the cash flows, the lower risk of the company, and the lower your cost of capital is because it shrinks that risk premium. Car washing, and the emergence of unlimited plans, offers tremendous stability and cash flows. And that’s what we’ve seen from the valuations and the expansion multiples in this space because it offers such an attractive, stable cash flow generation business.
Thank you for sharing these aspects today. I wanted to leave our listeners with just kind of the overarching theme of what can they do and what we need to be aware of. But also, that it’s not all bad.
Yes, to no surprise, there’s a lot of risk in today’s environment between everything getting more expensive geopolitical uncertainty tensions between the Russia and Ukraine. That being said, complacency is not your best bet right now! You know, this is time to look hard at your business, and implement some strategic measures to protect yourself in a rising costs environment. So from an operator perspective, the good news is industry dynamics still present a very attractive opportunity. There are a number of solutions to your disposal to be able to successfully navigate the current environment. As it relates to the M&A side of the business, definitely some things to consider here. But we still see, you know, a robust pipeline of activity for the long term, because again, while we’re dealing with short term dynamics, the longer-term characteristics of this industry present an abundance of opportunities for buyers. So, we do not see that changing anytime soon. Another positive here, so something we didn’t get a chance to talk about… But something else to consider here, too, is we talk about wage inflation. Wage inflation has… it’s different along different rungs of the income spectrum. So, what I mean by that is, on average, across the entirety of our country, the average employee is seeing about a 5% increase in their wages. Now, that’s important, that helps to soften the blow 8% inflation, right? That results in a 3% reduction in real wages, as opposed to 8% blow.
Right. That’s a huge difference!
Huge difference. But when you even take finer cuts of this, you know, there are certainly some reasons to find optimism here. So if you were to look at the lowest 1/3 income generators in the country, they spend approximately 15% of their income on energy and fuel, okay? Now, if you’re to look, that same segment, that group has, by and large, been the biggest beneficiary of wage inflation. On average, their wages have increased by approximately 8%. So you actually see slightly positive increases in real wages for that demographic. And I think, you know, as we talk about the impact of inflation on the consumer, one reason why markets and specifically car washing have been resilient over the past years, is because as we take finer cuts of who is actually impacted here, that demographic of income producers that spend the most on gasoline have actually been the biggest beneficiary of wage inflation and wage increases here. So, that’s been a little bit of an offsetting effect there from a consumer standpoint.
And that’s important, because that means that their discretionary income, while they’re spending more on fuel, because of the rising wages, that they do still have even a little bit more discretionary income.
That’s correct. On a real wage basis, their real wages are actually positive over the last year, because they’ve actually had… They’ve seen some greater inflation. A lot of it’s just due to rising minimum wages across the country. And we see that as a big theme that we’re all acutely familiar with that in the car washing space here. I don’t believe any of us have seen wages go the opposite direction. If anything, it’s probably uniformly expensive for most of us. But nonetheless, that has been a positive in the grand scheme of things because that consumer who spends more of their income on fuel has been able to absorb some of that impact because their wages are up.
To your point there, those rising wage prices that operators feel on what the you know, the amount that they’re spending on labor, it’s not just that the car wash labor wage has risen. It’s that all of that sector has risen, so more people have more disposable income, or at least it’s offset. So, while it is difficult for an owner to absorb those higher wages, there are changes and strategies that we talked about of how you could offset that. And the bright side of that is that there’s still more money out there for consumers to come and use the car wash.
Thank you, Chris, for joining us today and being our second guest on Car Wash M&A, The Podcast. I really enjoy having you on, and as a side note, I enjoy working with you as a teammate!
Thanks for sharing. Be sure to listen to Car Wash M&A, The Podcast. The new episodes release the last Thursday of every month. You can find us on your favorite podcast app, or wherever you choose to listen to us, or on our website at amplifywash.com/podcast. Thanks so much! See you next time.