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AutoZone May Be a Solid Long-Term Investment

October 10, 2013 | About:
P.I.A.

P.I.A.

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AutoZone (AZO) announced earnings on Wednesday, Sept. 25, beating estimates and reporting $10.42 per share. It is clear in listening to the conference call that the auto parts specialty retailer is a competitive operation. However, some are not currently as enthusiastic and O’Reilly Automotive Inc. (ORLY) has been outperforming.

A simple set-it and forget-it investment in AZO over the past decade would be up around 350%, compared to 69% for the rest of the S&P 500, and 126% for Berkshire Hathaway (BRK.A)(BRK.B). The stock has done well for a number of reasons. Drivers remain:

· It has anticyclical attributes as people fix their own cars (“DIY”) when they are on budgets, such as when there is problematic unemployment.

· AutoZone is the largest company of its kind with 5,201 stores, and its plan is to continue growing square footage. It currently has 362 stores in Mexico, with 21 opened during the recently concluded Quarter Four. Of its foremost competitors, O'Reilly and Advance Auto Parts (AAP), it is the only one with an expanding international presence in Mexico.

· There are also three stores in Brazil, with a plan for 10 to 15 before reevaluation.

· The company’s voracious, nonstop buyback plan has also paid off: AutoZone uses all of its free cash flow, maxes out its accounts payable, and incurs debt to the point that it can maintain an investment grade credit rating (2.5x EBITDAR) in order to repurchase shares. In the fourth quarter, $560 million has been bought back, and the company’s market cap is just under $16 billion.

· People are keeping their cars on the road longer, resulting in their ongoing maintenance. Purchases of traded-in vehicles also result in repairs and enhancements and therefore business for the company.

· While it lags its competitors in commercial operations, meaning supplying parts to professional shops, improvement is another means for growth. In order to address this issue, CFO Willliam Giles cites maturation of its marketing program and inventory assortment additions.

· Using GuruFocus’s DCF Calculator, the company has a fair value of $642, or $588 in consideration of tangible book value, resulting in a 29% margin of safety.

Goldman Sachs rates AutoZone a "buy" as of Sept. 27 with a $470 12-month price target. Here is part of its note:

Implications

"We cut forecasts to account for lower SSS trends and sticky SG&A. EPS estimates for FY14/FY15 go to $30.25/$33.80 from $31.00/$34.75. We also introduce FY16 estimate of $37.50. Given AZO’s very strong financial profile, we are inclined to give the firm the time to work through issues; financial risk is limited, and valuation leaves some room to maneuver."
Valuation

"
We hike our 12-month target price to $470 from $456 on a roll-forward of estimates, offset by our lower forecasts. Our target price is based on risk/reward (EV/EBITDA). Valuation looks undemanding relative to peers."
Goldman’s report is thorough enough that I would like to provide detail. A table summarizes the firm’s findings:

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The firm also keeps a YoY inflation index of motor oils, fluids, filters, washes, and waxes for ORLY, AAP, and AZO. Since July 22, AZO’s prices have risen at close to 13%, whilst the total index has been up 5.8%, to 9.2%. According to Goldman, AutoZone management says a non-inflationary environment is providing pressure in contrast to the firm’s own index.

UBS has two notes issued on Sept. 25. Much of the same topics are discussed, however a Neutral rating in place since July 2011 (when shares traded for $300) is reiterated, and a $430 price target is assigned. The Swiss firm observes that a sharply “Accelerated pace of its commercial expansion with 173 openings vs. 102 last quarter... should boost the DIFM biz ahead.“

In its other note, UBS says:

"During 4Q, AZO’s TTM ROIC was 32.7% as it remained intently focused on maximizing this key metric. Over time, we think it can still earn a very handsome return (well in excess of its WACC) while it invests in its supply chain and parts availability. But, it might have to sacrifice some of its return profile to do so…Our $430 price target is based on 13x our CY’14E EPS of $31.93… Compared to peers, AZO has a substantial opportunity to close the commercial productivity gap."

Strangely, a $31.93 EPS estimate for 2014 is higher than Goldman’s $30.25. The comment on WACC is pertinent to a valuation using the DCF calculator. As such, value is offered in addition to a long-term growth story.

AutoZone is off slightly since earnings and currently is priced at around $419. There is also appeal because the company can be counted on to buy back shares at times like now when it trades sideways. There is an imaginable day when the amount of stock left available would be severely limited, and shares might be somewhat illiquid and expensive.

Until then, AutoZone should be viewed favorably because of international expansion, other growth prospects, cheap valuation and security against any economic slowdown.

Rating: 4.2/5 (5 votes)

Comments

P.I.A.
P.I.A. - 10 months ago
Hi, thanks for the comment. I believe myself signed up to be notified via email, but have not gotten any message(s).

There are some who point to insider selling at AutoZone. The guy who has really gotten rich doing it is Eddie Lampert (who must be smarter than just about everyone except you and I put together :) and must have enough cash on hand to buy JCP). It might be ironic that two directors have actually made purchases coincident with this article. With shares worth $100s each, it seems to me that it would just be human tendency to cash them in.

I observe from some of your web presences that you like options, and perhaps favor selling puts. ORLY is scheduled to report on Wednesday, but is near 52 week highs. Even though ORLY tends to beat estimates and rise when it reports, I am hesitant....good luck with that TGT trade that you have written about somewhere else...XOOM might be going above $37.50 but its options have liquidity issues.

Some people criticize buybacks as creating financial improvement when there is no underlying operational growth. That is not clearly the case with AutoZone although there is some sluggishness. Admittedly, a better sense of how new cars are selling in Mexico might be helpful in the future...

Goldman Sachs has no fewer than four people covering AZO...

P.I.A.
P.I.A. - 10 months ago
I have spent some time talking to a service advisor at a repair shop. He makes it clear that big national chains such as AZO and AAP are not who he turns to for parts (ORLY has negligible local presence). There are several reasons: other companies are willing to refund labor costs if a part is defective, national chains do not; his computer system brings up pricing and availability at several locations, we did not discuss Z net; other companies offer some sort of incentive for recognizing ASE certification of his mechanics, whereas he remarks about AZO that "Those are the do it yourselfers."

There is nothing conclusive, but my inclination is to say that the insider buying may not be predictive (curiously, it has coincided with AAP's enormous acquisition). New cars are selling, new store footage might offset declining same store sales and market share. They are probably going to need commercial business to show operational improvement. Hypothetically, if a year and a half goes by with in-line results, and they buy back stock at the same rates, we could have 20% of shares removed from the market while the P/E declines commensurately. However, if they can then get things right it could really go higher so it seems to be appropriate for those with long term horizons.

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