In this article, let's take a look at Memphis-based AutoZone Inc. (AZO, Financial), a $17.49 billion market cap company, which is a retailer of automotive parts and accessories.
Interamerican Motor Corporation acquisition
Yesterday, it was announced that the company reached an agreement to buy Interamerican Motor Corporation, the second-largest distributor of OEM ((original equipment) quality import replacement parts. Although this firm has a small size, we think it is a coherent buy to the business model. Bill Rhodes, president and CEO of AutoZone, said in a news release: "As we expand the IMC brand across the United States, we believe the IMC business model will mutually benefit both our retail and commercial customers. The combined offering is expected to deliver value for our customers and stockholders".
Lower costs
AutoZone operates over 5,000 AutoZone stores throughout most of the U.S. It operates as well in promising countries such as Mexico and Brazil.
The company has more sales and market share than its rivals, and has an effective way to promote its own private labels, Duralast and Valucraft. These products are very important because counting both of them; they generate over half of sales. This also contributes to negotiate with good terms with vendors, obviously resulting in lower costs.
Serious management
With respect to the management of the company, we believe they are good oriented and places emphasis on ensuring that new investments exceed the internal rate of return. When compared to its peers, AutoZone employs more capital-intensive strategies.
Revenues, margins and profitability
Looking at profitability, revenue growth by 6.15% led earnings per share increased in the most recent quarter compared to the samequarter a year ago ($8.46 vs $7.26). During the past fiscal year, the company increased its bottom line. It earned $27.88 versus $23.57 in the prior year. This year, Wall Street expects an improvement in earnings ($31.56 versus $27.88).
Finally, let´s see a measure defined by Joel Greenblatt (Trades, Portfolio): the Return on Capital, which he analyzed it differently in his book “The Little Book That Still Beats the Market (Little Books. Big Profits).” He defined Return on Capital as EBIT divided by the total of net fixed assets and net working capital.
The formula is: Return on Capital: EBIT/(Net Working Capital + Net PPE – Excess Cash)
So, let´s compare the ROC which is one of the most important measures of the efficiency of a business and should be an important tool for investors.
| Ticker | Company | ROC (%) |
| AZO | AutoZone | 57.73 |
| AAP | Advance Auto Parts Inc | 47.27 |
| ORLY | O'Reilly Automotive Inc | 42.34 |
| Industry Median | 20.04 |
The ROC is higher than 91% of the 1120 companies in the industry. AutoZone has a current ROC of 57.73% which is the highest in the last 13 years and is also higher than the industry median.
It is very important to understand this metric before investing and it is important to look at the trend in ROC over time.
Through good working capital management, the company generates those attractive levels that trended up over the last five years.
Relative Valuation
In terms of valuation, the stock sells at a trailing P/E of 17.3x, trading at a discount compared to an average of 22.9x for the industry. To use another metric, its price-to-sales ratio of 1.94x indicates a premiumversus the industry average of 0.8x.
As we can see in the next chart, the stock price has an upward trend in the five-year period. If you had invested $10.000 five years ago, today you could have $35.071, which represents a 28.5% compound annual growth rate (CAGR).
Final comment
As outlined in the article, the firm enters into a definitive agreement to acquire Interamerican Motor, a small player in the industry, but we think is a strategic move. Moreover, its reduction on costs as well as good policy in what refers to investments, makes me feel that AutoZone is a well run company. Finally, the PE relative valuation and the return on capital that significantly exceeds the industry median and make me feel bullish on this stock.
Hedge fund gurus like Joel Greenblatt (Trades, Portfolio) and Jean-Marie Eveillard (Trades, Portfolio) added this stock to their portfolios in the second quarter of 2014.
Disclosure: Omar Venerio holds no position in any stocks mentioned
