Mister Car Wash Shines In Profitability, While Shares Appear Fairly Valued (NYSE:MCW) (2024)

Investment Thesis

Mister Car Wash (NYSE:MCW) is the largest publicly traded machine car wash operator in the U.S. Since the early 2000s, the firm has grown rapidly to become a nationwide chain of wash centres.

Since their IPO, profitability has failed to match lofty valuations. However, solid fiscal improvements in 2023 have coincided with a much fairer share price which, given a base-case outlook for 2024, may suggest a 15% undervaluation in shares.

Nevertheless, significant levels of growth are already baked-in to the current share price with any underperformance from a baseline 8% EPS growth estimate leaving shares slightly overvalued in a bear-case scenario.

I therefore rate MCW a Hold at present time.

Business Profile

Mister Car Wash is the largest automated car wash operator in the United States. With over 475 locations, MCW serves around 300 million customers per year across 21 states. The "Mister" brand is focused on offering customers a wide range of machine car washing and interior cleaning services so as to target a very broad set of potential client demographics.

From passers-by looking for a quick clean to loyal customers providing repeat business through Mister’s “Unlimited Wash Club” subscription service, MCW most probably has a product that matches the demands of any given car-driving consumer.

John Lai continues to serve as President and CEO having joined the firm back in 2002. Lai holds a significant amount of experience at the firm and is responsible for having grown the operation into the nationwide brand they are today.

Mister Car Wash’s Economic Moat

MCW’s operations generate what I deem to be a narrow economic moat thanks to perceived switching-costs facing consumers along with cost advantages enjoyed by the firm.

The quality of Mister Car Wash’s website, operations and branding is impressive. In an industry characterised by a large number of small-scale operators resulting in significant fragmentation, MCW has managed to differentiate themselves from the competition by developing their brand into a nation-wide phenomenon.

Standardised washes, add-ons and prices (although some variation in price does occur between states, the proportionate difference between services remains roughly constant) help assure consumers that they are getting the same quality of service no matter which Mister Car Wash they go to.

Trademarked signature products utilised in the cleaning service such as the “HotShine Carnauba Wax” and “T3 Conditioner” are just two examples of Mister Car Wash being experts at building a durable and recognisable brand.

Furthermore, the standardised image helps increase brand penetration as the same logo, wash names and service delivery can be experienced across the U.S.

During his tenure as CEO, Lai has also pursued the development of an extensive loyalty system that encourages consumers to purchase a WashPass or Unlimited Wash Club membership over a single wash service.

Price advantages for consumers, opportunities to skip lines and the ability to benefit from certain higher-end cleaning services such as HotShine wax at a perceived gratuity help entice consumers to purchase service packages that ensure repeat business for MCW.

The firm’s superb brand building helps differentiate MCW from the competition while their enticing loyalty programs focus on garnering repeat business from consumers. Together, these two factors generate what I believe to be powerful perceived switching costs among consumers which provides MCW with powerful pricing power.

MCW also benefits from what I believe are some cost-advantages compared to smaller competitors thanks to the scalability of machine car wash services. Given that MCW has been expanding at a rate of around 8% over the past year (opening just over 40 new locations in 2023 with a total of around 480 locations in operation), the firm certainly enjoys some cost advantages over its rivals.

From a capital investment perspective, such a rapid rate of growth should allow MCW to acquire the tunnel wash machines and interior vacuums at much lower unit costs than say a new competitor purchasing their first pieces of equipment.

Higher volume purchases of such machines (which cost around $180,000 without any discounts) may allow MCW to grow at a lower WACC than a smaller competitor which could provide a lasting long-term advantage.

The massive volume of washing operations means that MCW utilizes a huge amount of wash chemicals and products. Once again, it would be foolish to believe that the firm does not enjoy some cost-advantages with suppliers given the massive volumes in which MCW purchases these supplies.

Overall, I see the firm’s excellent ability to generate perceived switching costs for consumers along with their cost-advantage in operations as operational advantages worthy of earning Mister Car Wash a narrow economic moat rating.

Fiscal Analysis

Mister Car Wash is a relatively new public firm considering their IPO was in mid-2021. Nevertheless, the firm has been a mostly healthy enterprise since its initial public offering with three-year average ROA, ROE and ROIC of 3.22%, 6.21% and 5.14% respectively.

While these returns are not particularly stellar, it must be noted that pandemic-era restrictions experienced during 2021 hampered returns significantly. Without these impacts, ROA, ROE and ROIC hover around 3.86%, 12.98% and 5.79% respectively which are already much more generous.

MCW has also been growing at a rapid rate over the past two years with the firm investing significant capital into the opening of 35 greenfield sites along with 10 acquisitions of existing carwashes across the U.S.

Two-year average gross, operating and net margins of 69.55%, 20.63% and 10.24% illustrate just how profitable MCW’s core operations really are.

The superb 69% gross margins suggests that their wash business continues to enjoy real pricing power and is a fundamentally lucrative business while the excellent 20.63% operating margin is illustrative of an operationally efficient enterprise.

Operating margins have also expanded significantly from pre-covid levels with backdated data to 2019 suggesting margins of just 12%.

The recently released FY23 Q4 and full-year results further support the thesis that MCW is not pursuing growth at the expense of excellent business returns.

Fiscal-year 2023 was a pretty solid one for MCW. Net revenues grew 5.8% YoY to $927.1 million thanks to additional revenue from new stores, while comparable-store sales increased 0.3%.

A 0.3% increase in comparable-store sales may sound quite disappointing to many investors. However, this is actually more representative of a machine wash business operating at its maximum capacity rather than a lack of new customers.

The automated tunnel-style car washes used by Mister Car Wash have an hourly maximum capacity of automobiles. This maximum operating speed may hover between 30-120 cars per hour depending on the length of the tunnel.

Longer tunnels are able to handle more cars per given time period as the conveyor that pulls customer vehicles through the wash can load up to five cars at once.

As a result, car washes operating close to their maximum hourly capacity of vehicles will generate essentially consistent revenues with variance only arising from wash cycles purchased with no additional capacity for further in-store growth.

Therefore, any growth in revenues to be generated by MCW will almost certainly come from new-store expansion or a product mix improvement rather than comparable-store sales growth.

Circling back to FY23 results, I also like the product mix enjoyed by the firm with 74% of total wash sales arising from Ultimate Wash Club subscriptions up from about 71% in FY22.

Continued growth in MCW’s car wash subscription illustrates just how well the firm has been able to market the perceived value proposition present in the service to consumers. While MCW may be getting less revenue per wash with Wash Club sales, the repeat business generated by the service more than makes up for this unit price drop.

Unfortunately, 2023 saw labor and cleaning chemical costs rise 4% YoY as a result of inflationary supply-side pressures and rising employee wages. Other store operating expenses increased 13% YoY as a result of higher maintenance costs and electricity prices which drove-up operating expenses for the firm.

Total costs and expenses increased 8.7% respectively leaving the firm with an operating income of just $178M, down 5.2% YoY.

This decrease in operating income is a shame given the positive top-line growth achieved by Mister Car Wash. Nevertheless, I believe these pressures are more indicative or a transitionary set of macroeconomic conditions rather than an inherent weakness at MCW.

Total comprehensive income was down 29% YoY primarily as a result of a significant interest expense for the firm. The massive rise in interest rate expense (78% YoY) came due to higher average interest rates on loans held by the firm and due to an expiration of interest rate swaps.

As a result of the less than superb bottom-line results in 2023, Seeking Alpha’s Quant calculates a “D”, profitability rating for Mister Car Wash which I believe is an excessively pessimistic representation of the profitability present at the firm.

Careful analysis of MCW’s balance sheets reveals what can only be described as a mixed-bag of business economics.

Mister Car Wash has $60.9 million in total current assets while current liabilities amount to $169.6 million. The firm also only has around $19 million in cash and equivalents on their balance sheets.

This means the business currently has a pretty poor quick ratio of just 0.22x and a current ratio of just 0.35x suggesting short-term liquidity is compromised at MCW.

However, there are a few important points to consider with regards to their short-term liabilities. Firstly, as 74% of revenues arise from subscription sales, MCW has a whopping $32.7 million in unearned revenue on their balance sheets.

These unearned revenues will be periodically reduced by the amount of each individual liability combined as the service is provided (at least in principle of what the subscription affords the consumer the rights to).

While these unearned revenues do not concern be, it must be noted that MCW has $44.7 million in lease payments maturing in the next twelve months.

Considering that Mister Car Wash had negative $112 million in unlevered FCF in 2023 (which includes their investment into expansion and payment of leases), it is quite plausible that the firm will be forced to take-on further long-term debt in order to finance any additional expansion sustainably.

Total liabilities currently amount to $1.97 billion while the company holds $2.89 billion in total assets. MCW also has $915 million in shareholders equity leaving the firm with a slightly concerning debt/equity ratio of 1.93x and a financial leverage ratio of 3x.

The majority of these debts have arisen as a result of MCW's aggressive growth strategy which has seen the firm accumulate $897 million in long-term debentures.

The $901 million maturing in 2026 is a first-lien term loan that MCW has held in one form or another since February 2020. It is very improbable in my opinion that the firm would actually be required to repay this massive debenture in full in 2026.

Realistically, it can be expected that MCW will have the opportunity to refinance this loan and change the maturity profile.

The current interest rate of the loan is 8.46% which while quite elevated, is not an overly concerning rate considering how high average interest rates have risen over the past few years.

Overall, I believe MCW is a mostly profitable business that is growing at a remarkable rate. Management hopes to continue growth at around 8% per year with the firm opening 40 new greenfield locations in 2024 along with some acquisitions of existing car wash facilities.

My only concern arises from the debt loading which is quite significant at present time. While the $900 million in long-term debentures should be refinanced successfully before 2026, I believe it may be prudential for the firm to slightly slow the pace of growth so as to better safeguard their economics from a recessionary business environment.

Valuation

Seeking Alpha’s Quant calculates a “D+” valuation rating for Mister Car Wash stock. I believe this is an overly pessimistic letter grade which suggests an overvaluation may be present in shares. On the contrary, my research suggests share are materially undervalued at present time.

While a P/E GAAP TTM ratio of 27.04x may not be indicative of a deep-value opportunity, it must be recalled just how fast MCW is growing. Given the 10% increase in store count expected in 2024, I believe an 8% topline growth rate is reasonable to expect which would place MCW shares in potential GARP territory.

This changes the initial reaction one may have to a 27x P/E TTM ratio and suggests this growth may not entirely be account for in the current share price.

P/S TTM ratios of 2.18x are reasonable given the growth prospects while I see their P/CF TTM of 10.08x as a little elevated. However, as the firm continues to grow, I believe their operations will scale efficiently and see real cash generation potential on the horizon.

The past three-years have been tough for MCW shareholders. Since its IPO, MCW stock has lost 67% of its value as the company’s earnings have underperformed the levels demanded by initial valuations.

When compared to the 18% gains posted by the popular S&P500 tracking SPY (SPY) index fund, it is clear to see why MCW has been an unpopular security in recent times.

Nevertheless, the last six months has seen MCW surge from its lows of around $5 per share by 19% with increasingly solid FY23 quarterly results now being accompanied by a much fairer valuation.

To gain a more objective and quantitative perspective of the value present in the stock, we can use The Value Corner’s own Intrinsic Valuation Calculation.

Using the current share price of $6.67, a low-end estimate for full-year 2024 EPS of $0.32, a realistic “r” value of 0.08 (8%) and the current Moody’s Seasoned AAA Corporate Bond Yield ratio of 5.01x, I derive a base-case IV of $7.70 per share. This represents a 13% undervaluation at present time.

When using a bear-case CAGR value for r of 0.05 (5%) to reflect how a recession may reduce comparable store-sales thus offsetting growth from entirely new locations, shares are only valued at around $5.80 thus suggesting a slight 15% overvaluation in the stock.

The real variance in valuations between a base and bear-case calculation illustrates the uncertainty present in short-term valuations (1-12 months) for MCW stock. The large impact even a small underperformance in EPS growth may have on shares illustrates how much growth is already being baked-in to MCW stock price.

This expected growth being priced-in opens the door for uncertainty which ultimately reduces the conviction I feel comfortable assigning to any potential opportunity in shares.

Still, I really like the Mister Car Wash formula of business and believe that in the long-run (2-10 years) the firm is well positioned to continue developing the brand into a truly world-class operation.

Mister Car Wash Risk Profile

The firm faces real risk from a cyclical consumer demand environment. Any recessionary business environment could result in consumers being less willing and able to spend their increasingly constricted levels of disposable income on non-essential items such as car washes.

While it could be argued that car washes are a quasi-essential service and that the subscription model pursued by MCW may increasing switching costs for consumers, I realistically believe the total sales per store could decrease by around 5-10% in a recessionary market environment.

This would place a real damper on MCW growth plans as profitability would almost certainly take a real hit in such a scenario. While car washes can scale-back operations quite successfully with most costs being variable (chemicals, water and electricity), total revenues would still suffer.

I also see MCW suffering from a finance risk acute to their business operations. Given the significant debt load present at the firm, a refinancing of these liabilities at higher interest rates could result in interest rate expenses growing even larger than they already are.

While a lower-rate environment may emerge should the U.S. economy begin to experienced slower growth, a higher-for-longer environment could hurt the firm’s net income tangibly.

From an ESG perspective Mister Car Wash does not face any real concerns.

Considering these concerns, I believe MCW has a medium-risk profile and recommend investors always conduct their own research into risk and ESG matters before investing as these topics are inherently subjective.

Summary

Overall, I like what Mister Car Wash is doing as a business. Their strategy of offering of a wash subscription and highly standardized services across the U.S. helps differentiate the firm from the vast sea of fragmented competitors while also offering a real value proposition to consumers.

While 2023 has been an improvement for the firm with regards to profitability and margins, I remain slightly cautious about the debt burden present at MCW. While growth is clearly an important element of their current operations, any underperformance relative to expectations could send shares further downwards.

Therefore, I currently rate Mister Car Wash a Hold. While I like the business, a greater margin of safety would be required for me to initiate a position given the speculative elements associated with future growth expectations.

The Value Corner - Brought to you by HaavistoBuffett style picks fit for the modern investor.Six years of long-horizon investment portfolio management and consulting. I focus on creating portfolio value through synergetic stock picks and ETFs to create robust and profitable value generation solutions. I do not provide or publish investment advice on Seeking Alpha. My articles are opinion pieces only and are not soliciting any content or security. Opinions expressed in my articles are purely my own. My opinions may change at any time and without notice. Please conduct your own research and analysis before purchasing a security or making investment decisions.