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Why O'Reilly Is the Best Pick for Investors in Aftermarket Retail

May 21, 2014 | About:
kcpl

kcpl

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O’Reilly Automotive (ORLY) is the one stock that has performed exceedingly well during the past one year among various auto parts retailers that had strong gains during 2013. O’Reilly’s stock has been unstoppable as it has gained almost 27% so far this year, outpacing its peers and the kind of potential outlook it provides, I doubt if this momentum can be interrupted going forward.

There are various reasons for the stock to rise such as stellar earnings reports and the strategic initiatives it had taken to return cash to shareholders through buybacks. Also, investors can certainly think of having the stock in their investment portfolio as the company delivered strong growth in same-store sales, while its peers such as Advance Auto Parts (AAP) and Auto Zone (AZO) have been struggling with negative same-store sales.

Standing Tall

O’Reilly has done enough and stands to benefit from the high average age of vehicles on the U.S. roads, which is at 10.8 years. While sales of new vehicles might be picking up due to the housing rebound and consumers finally deciding to upgrade, it is unmistakable that vehicles require maintenance and routine maintenance of vehicles will lead to better revenue for the company going forward.

In addition, the company believes that its new vehicles that are being manufactured are superior in terms of engineering and manufacturing, and this should assist the company in achieving long-term success. Besides, the complexity in the engineering of the new vehicles means costlier parts that result in higher sales, and this was one of the reasons for O’Reilly’s solid performance in the previous quarter.

Strategies to Drive Growth

Furthermore, the company looks solid to earn additional market share with the combination of older vehicles on the road and an increasing number of new, state-of-the-art vehicles that positively indicate that aftermarket retailers aren’t going out of the business. Hence, the positive outlook for new vehicles sales this year is beneficial for the likes of O’Reilly in the coming years. Also, this will make the companies in this sector solid picks irrespective of the state of the economy as the older vehicles will ultimately require maintenance.

Additionally, the company has been aggressively opening stores and distribution centers to benefit from the rising number of vehicles on the road. This will certainly help the company to put better margins in the current and upcoming quarters. O’Reilly is determined to open nearly 190 stores this year as it looks to expand its network and compete with the others. The company’s distribution centers have been contributing to its efficiency and leading to gross margin growth.

O’Reilly looks focused to bolster its presence in the higher margin do-it-yourself market further through initiatives such as a new loyalty card program. Also, the company has been rolling out its business-to-business, or B2B, platform so as to satisfy customers’ requirement in a more efficient manner. All these initiatives should increase its revenue and net profit growth going forward, while an impressive share repurchase program should aid earnings growth further.

Also the recent decision of the company to increase its share repurchase authorization by $500 million, taking the total authorization to $3.5 billion, should bring in many new investors. As the company believes in returning cash to shareholders through repurchases and uses excess cash for the purpose, and I think that this is the right way to go.

Valuation Concerns

However, one point of contention which might stick out is that O’Reilly is expensively valued as compared to peers and also the fact that it’s trading near its 52-week high. A trailing earnings multiple of 22.5 times looks expensive when stacked against Advance Auto’s and AutoZone’s 16 times. But then, none of the other two have been in green territory as far as same-store sales are concerned and as such, O’Reilly deserves the premium valuation.

On the other side, AutoZone’s same-store sales had dropped 0.1% in the previous quarter but revenue and earnings were up 4.5% and 7%, respectively. In comparison, O’Reilly delivered 1.9% same-store sales growth, revenue growth of 4% and earnings growth of 19% thus making it more superior to Auto Zone. Moreover, AutoZone’s huge debt load of $4 billion is something which investors should worry about, and this further makes O’Reilly more attractive since its debt is just $1.1 billion and it has ample cash flow to deal with it.

However, Advance Auto might prove to be a good choice as well, and could provide some tough competition to O’Reilly as it’s been rapidly growing its business by aggressively building stores and making acquisitions. However, the company had experienced a 9% decline in profit and 3.2% decline in same-store sales in its previous quarter due to various factors. Hence, when you’re getting a company which is delivering growth and value to shareholders in the form of O’Reilly, I think it would be more prudent to go with it rather than considering the others.

Conclusion

Considering all these factors, O’Reilly’s premium valuation is justified and I believe that it is the stock to pick in this industry right now. Going forward, analysts expect the company to grow its earnings at 16% for the next five years, at par with the industry average, but I won’t be surprised if O’Reilly keeps outperforming the industry like it has done so far.


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