AutoZone (AZO): Industry Leader by Revenue and Margin Yet Undervalued Relative to Peers; Tremendous Growth Upside; Strong History of Share Buybacks

AutoZone (AZO) is America’s leading retailer and distributor of a broad array of new and refurbished vehicle replacement parts and accessories for automobiles and light trucks, with a growing international footprint and digital properties that enhance the company’s online presence.

AutoZone has significant upside potential through expansion of its commercial, international and digital businesses, and benefits from an aging U.S. vehicle fleet, strong aftermarket demand in extreme weather, record share buybacks and strong organic growth across multiple vectors with no signs of stopping. AutoZone also beats out online retailers such as Amazon.com (AMZN) which do not take in returns, old batteries or recycle engine oil. So shares should steadily gain in the coming years.

Based on Wall Street consensus estimates of 15.4% annual earnings growth, FastGraphs estimates that shares
could rise to $935 over the next five years and deliver an 11% annualized return. With Q3 diluted EPS of $8.46 per share ($33.84 annualized) and shares at $532.50 (as of 5/30/2014), the company is valued at about 15.7x forward earnings, which is in-line with its earnings growth rate.

 

AutoZone had 2013 full year revenues of about $9.1 billion, with EBITDA of about $2 billion. The company has very strong cash flow and has, through the years, bought back roughly 60% of outstanding shares through buybacks. AutoZone has grown revenues at a 5.1% CAGR over the past 10-years and picked up the pace of revenue growth to 7% over the past five years.

In its most recent quarter (Q3 2014 ended May 10), net sales were up 6%, net income was up 7% and diluted EPS was up 16%. And shares are up 230% over the past five years to $532.50 (as of 5/30/2014), with a 20-year annualized return of 17%. AutoZone does not pay dividends.

Favorable Comps Show Valuation Upside

AutoZone does, however, have strong competition from Advance Auto Parts (AAP; which acquired Carquest in 2013), privately held NAPA, Pep Boys (PBY; which also provides repair services in-house) and O’Reilly Auto Parts (ORLY), and a bunch of smaller players.

On revenue, market cap and EBITD margin, AutoZone is well ahead of its top competitors. Even so, AutoZone shares are priced at a substantially lower P/E ratio than peers, which suggests two things – that there could be significant upside as shares play catch-up on valuation ratios, and that shares are more reasonably priced than peers and offer compelling value at current levels.

 


Strategic Growth Initiatives – Four Growth Vectors

AutoZone plans to grow along four vectors – parts and accessories sold to do-it-yourselfers (DIY), through expanded commercial offerings (for which AutoZone recently bulked up specialized inventory and came in for some misguided criticism from a few analysts who do not see the long-term growth potential of inventory investments for its commercial buyers), through selective ongoing international expansion in South America (with opportunities also being explored in Europe and Asia) and through better integration of its digital (online) properties.

As of May 10, 2014, AutoZone had 4,901 domestic (U.S. based) stores, 374 stores in Mexico and 4 stores in Brazil, for a total of 5,279 stores – with about 150 new stores added over the past three quarters. AutoZone has two main business segments – retail operations which account for about 80% of revenue, and commercial sales which bring in about 20%. Seventy-five percent of the company’s stores have “commercial sales programs” where knowledgeable personnel answer in-person and telephone enquiries for commercial customers and large buyers. In addition, the company has digital properties that it is focused on integrating into its core business model.

Strong Growth in Core DIY Market

For the U.S. DIY auto aftermarket segment, as a whole, annual sales have grown at a 2.8% compounded annual growth rate (CAGR) to over $47 billion per year. Within this segment, AutoZone has established itself as the industry leader with #1 market share with well-groomed stores staffed by experts for a good customer service experience. This segment caters to enthusiastic DIYers who like to repair and do-up their vehicles without professional help.

AutoZone is expanding its DIY marketshare through the opening of new consumer-friendly stores and a focus on excellent customer service, innovative marketing, scientific category and inventory selection and management and online integration.

Positive Growth Dynamics in Commercial Auto Aftermarket

The commercial segment caters to auto mechanic, auto body and repair shops and is a $59 billion industry in the U.S. that’s been growing at 2.9% annually, and consolidating market share in a highly-fragmented industry. AutoZone has annual sales of $1.5 billion in this segment, and currently only has about 2% market share but anticipates strong market share growth upside through careful advertising, promotion, inventory and logistics initiatives.

Currently, over 75% of AutoZone stores (or 3,732 stores) have a commercial sales program with knowledgeable experts who can intelligently cater to the commercial auto repair sector, new training programs based on customer feedback, studies to improve program productivity and better availability of parts.

Digital & Mobile Properties Integral to Changing Customer Needs

AutoZone’s digital properties include ALLDATA (www.alldata.com) which provides comprehensive OEM information on auto parts, service and repair to repair and collision shops globally, with 80,000 active customers (and growing) who depend on the service to function efficiently and bring in customers. Alldata also has a mobile application and caters to the repair, collision and DIY sectors.

In December 2013, the company acquired AutoAnything (www.AutoAnything.com), a fast growing online retailer of specialized automotive products from top, trusted brands. AutoAnything focuses on performance parts such as turbochargers and suspensions, exterior accessories such as truck bed liners, bike racks and wheels, and interior accessories such as seats and seat covers. AutoAnything offers specials through its partners, offers a lower price guarantee and has in-house experts to guide purchasing decisions.

The company’s own website (www.AutoZone.com) has extensive information on parts and accessories by car make and model, and has information on virtually everything needed to service or repair vehicles. The site also has a DIY library to trouble-shooting and repair, with features such as free shipping, “same day store pickup” and “return anywhere”.

Consistent EBIT, EPS Growth over Past 10 Years

Over the past ten years, AutoZone has consistently increased EBIT (Earnings before Interest and Taxes), with no down years even through the 2008 recession, and delivered 5-year EBIT growth of 9.1%. This reflects strong underlying recession-proof demand for products it sells, and its superior competitive positioning in a crowded auto-retail space.

 


 

Earnings too have grown impressively over the past ten years, fueled in part by strong buybacks. AutoZone’s EPS is up 22.6% annually over the past five years.

 


Q3 Results – 31st Consecutive Quarter of 10%+ EPS Growth

AutoZone reported stellar third quarter results (12 weeks ended 5/10/2014) with net sales up 6% to $2.3 billion, 17 basis points in gross margin expansion to 52% and a 3.9% decrease in operating expense ratio that delivered a 5% increase in operating profit (EBIT). Same store sales were up 4%. The company also reduced interest expense by 14%. Net income was up 7% to $285 million with a 16% increase in diluted EPS to $8.46. The company did $406 million in domestic commercial sales, a 14% increase over the year-ago quarter.

In its most recent quarter, diluted EPS was up 16%, marking the company’s 31st consecutive quarter of double-digit EPS growth, aided by a harsh winter and strong demand for starters, alternators and batteries. AutoZone also benefited from economic uncertainty that reduced new car sales and increased maintenance and repair outlays.


In the quarter, AutoZone added 30 new stores in the U.S. and 7 in Mexico, with 5,279 stores in total at year end, each with about 6,600 square feet on average.

In the quarter, AutoZone spent $420 million to buyback 795,000 shares, which was partly financed by $57 million in new debt. At year end, the company had $4.4 billion in total debt, up from $4 billion a year-ago, but benefited from lower interest rates on debt which brought down interest payments.

Wall Street was disappointed by the 12% increase in total inventory, to $3.1 billion, a drop in inventory turns to 1.5x from 1.6x and a 1.4% drop in gross profit per dollar of inventory, and this raised concerns about diminishing returns from its inventory expansion initiative, and sent shares down about 2% after results were announced. However, parts inventories are typically financed by vendors, so the inventory expansion risk should not be a concern.

AutoZone’s spate of buybacks has resulted in a shareholders’ deficit of $1.8 billion, even lower than the $1.5 billion deficit a year-ago.

Summary

AutoZone has steadily increased store count, added commercial programs, invested in additional inventory to support its commercial programs and improved logistics for margin expansion. In addition, AutoZone is expanding internationally (with significant untapped global growth opportunities) and enhancing its online information and e-commerce capabilities on the B2C and B2B fronts.

As cars become more computerized, traditional DIY becomes more difficult so AutoZone could consider vertical integration by getting into the auto repair business and follow in the footsteps of competitor Advance Auto Parts (AAP) to counter slowing DIY market growth. Cars are also getting more reliable, while the company’s expanding debt is a concern.

However, for now, AutoZone appears focused on expanding its multi-channel sales and boosting commercial and online sales, and shares offer significant upside potential over the next five years.

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