O’Reilly Automotive Inc. (ORLY, Financial) currently holds a spot on the Undervalued Predictable screener list at GuruFocus due to a couple of recent dips in the share price:
The company is one of the big four auto parts retailers, a group that is making the most of favorable tailwinds, factors such as lower gas prices, more total miles driven and even better quality cars (see also AutoZone: Debt Is a Dragging Brake on This Muscle Car).
O’Reilly has more than 4,700 stores, all of them in the United States, and plans to keep adding more. It is an ambitious company, one that has borrowed to help fund growth internally and through acquisitions.
So, is O’Reilly a value stock or simply a growth stock that has hit some turbulence?
History
1957: Charles F. O'Reilly (father) and Charles H. O'Reilly (son) leave the auto parts store in Springfield, Missouri where they work to start their own store.
1993: The company goes public on Nasdaq, symbol ORLY.
1998: Merger with Hi/LO Auto Supply, adding 182 stores.
2000: Acquires KarPro Auto Parts, which includes a distribution center and 14 stores.
2001: Acquisition of Mid-State Automotive Distributors Inc., adding 82 stores and two distribution centers.
2005: Acquisition of Midwest Automotive Distributors Inc., adding 72 stores and two distribution centers.
2008: Acquires CSK Auto, adding 1,324 stores.
2012: Acquires the auto parts business of VIP Parts, Tires and Service, a chain of 56 stores.
2016: Announces intention to buy Bond Auto Parts, a 51-store chain.
History based on information at the company website and Wikipedia.org.
O'Reilly's is a nearly 60-year old company that has shown an appetite for growth through acquisitions.
O’Reilly’s business
O'Reilly Automotive Inc. is one of America’s largest specialty retailers of auto parts (aftermarket, tools, supplies, equipment and accessories). In what it calls its Dual Market Strategy, it sells to both do-it-yourselfers ("DIY") and professional service providers such as auto repair shops (unless otherwise noted, information in this article comes from O’Reilly’s 10-K for 2015).
Three main types of goods are sold in its more than 4,700 stores:
- Hard parts: What we would typically think of as auto parts, such as engine components and batteries. The stores sell both new and remanufactured parts.
- Maintenance supplies: Oil, filters, wiper blades, light bulbs and other consumables.
- Accessories: Examples include floor mats, seat covers and truck accessories.
Stores carry, on average, about 23,000 SKUs (products requiring separate identity numbers). Hub stores carry an average of 44,000 SKUs; Hubs also serve as secondary suppliers to regular stores. Both types are supplied (usually five nights a week) by distribution centers (DCs) which carry an average of 146,000 SKUs.
The company has a tiered retail approach to serving two types of customers, do-it-yourselfers and professional services customers. We can also infer that sophisticated inventory and management systems underlie its ability to control and coordinate this many stores.
Revenue
As the following 10-year chart shows, the company increased its revenue significantly over the past decade:
This chart contains an estimate for 2016, shown on the right. It indicates the upward trajectory continuing through the remainder of this year.
In 2015, 58% of revenue came from the DIY market and 42% from the professional services market. The company notes it is growing the latter more rapidly because of the professional services industry structure. It has a sales staff of 700 that calls regularly on the auto repair shops.
The company does not report any revenue from online sales, although it has a digital presence in marketing and advertising.
O’Reilly has a history of growing its revenue and will likely continue this year. It has two distinct streams within the auto repair universe.
Competition
The auto parts industry is dominated by four major players:
- O’Reilly Automotive
- Advance Auto Parts (AAP, Financial)
- AutoZone (AZO, Financial)
- Genuine Parts (GPC, Financial) or NAPA
This GuruFocus table shows that O’Reilly is the smallest of the big four in terms of revenue, but has the largest market cap:
In addition to these three competitors, it also faces competition from:
- Regionally-based retail and wholesale chains that sell auto parts;
- Wholesalers or jobber stores (some associated with national automotive parts distributors or associations, including NAPA, CARQUEST, Bumper to Bumper and Auto Value);
- Automobile dealers; and
- Mass merchandisers such as Wal-Mart (WMT, Financial).
Also as noted in the AutoZone article, the auto parts business has not experienced serious competition from Amazon (AMZN, Financial) and other online retailers.
O’Reilly says competition is based primarily on pricing, which generally reflects the prices at competitors in the market area served by each store. Underlying that is a strategy based on “...a combination of internal gross margin targets and competitive reviews, with additional savings offered on some items through special promotional pricing and volume discounts.”
A highly competitive industry, however O’Reilly has made it to a top 4 position, albeit the one with the least revenue. Competition is driven mainly by prices, with which O’Reilly is dealing effectively.
O’Reilly’s moat
The company says it has several competitive advantages that cannot be duplicated easily:
- The dual market strategy.
- Superior customer service, including technically proficient store personnel.
- The strategic distribution network.
- An experienced management team.
In reference to customer service, it says in its 2015 Annual Report, “Our customer service Culture, our single greatest competitive advantage, was the driving force behind our record-breaking performance in 2015 and will be the key to our ongoing success in the future.”
Behind the customer service advantage is a systematic human resources system that includes stringent hiring criteria, the diffusion and reinforcement of a customer service culture and extensive training for parts people.
On management ability, the company refers, in its 10-K, to “. . . 23 consecutive years of record revenues and earnings and positive comparable store sales results since becoming a public company in April of 1993.”
In addition, O’Reilly and other auto parts retailers benefit from trends that see improved quality in new cars. In the Annual Report for 2015, the chief executive officer and the chief financial officer write, “These better-engineered and manufactured vehicles have the ability to stay on the road longer and can be reliably driven at very high mileages resulting in more routine maintenance cycles.” In other words, cars are traveling more miles before going to junk yards.
Although O’Reilly operates in an industry with low barriers to entry, it does have several competitive advantages that will allow it to keep growing and posting good margins.
Growth
The company lays out a multi-point growth strategy in its 10-K for 2015:
- Aggressively open new stores.
- Grow sales in existing stores.
- Selectively pursue strategic acquisitions.
- Enhance store design and location.
- Enhance the growth and functionality of the e-commerce website.
The company does not give any indications it plans to expand beyond domestic borders.
It reports that the most important factor driving growth is total miles driven in the U.S., and thanks to lower gas prices, 2015 saw 3.5% more miles. In addition, we would expect a growing economy to contribute positively to miles driven.
As for growth through acquisitions, it says in its Annual Report that there are chains that match its selection criteria (culture, footprint and potential ROI) which it is monitoring.
O’Reilly has an articulated plan to grow its business through elements it controls and external elements that are expected to continue in its favor.
Other
O’Reilly Automotive Inc. is incorporated in Missouri and headquartered in Springfield, Missouri.
It has some 71,000 employees as of Dec. 31.
Chairman: David E. O'Reilly, age 66.
President and Chief Executive Officer: Gregory Henslee, age 55.
Chief Financial Officer and Executive Vice President – Finance: Thomas McFall, age 45.
Ownership
Fourteen of the investing gurus followed by GuruFocus have holdings in O’Reilly; largest among them is Spiros Segalas (Trades, Portfolio), who owns 1,897,539 shares, or slightly better than 2% of shares outstanding. Ruane Cunniff (Trades, Portfolio) and Lee Ainslie have the second and third-largest holdings.
Institutional investors (including pension funds and mutual funds) have a high proportion of the company’s shares:
As this chart shows, short sellers have increased their positions over the past two years:
Members of the founding family, the O’Reillys, are the biggest players among insiders, with four family members accounting for more than 637,000 shares. CEO Henslee owns 22,505 shares.
While the shorts have increased their stake, the company has a very respectable 87% of its shares in institutional hands; the family and CEO also have sizeable stakes.
O’Reilly by the numbers
The current share price is closing in on the 52-week high; at the close of trading on Dec. 14, it was just $16 or 5.5% below. The ROA and ROE are both high, the company does not pay a dividend and it bought back more than 4% of its own shares in 2015.
Financial strength
The GuruFocus system gives O’Reilly a 6 out of 10 for financial strength and a 9 out of 10 for growth and profitability:
As we see in this table, the company’s key debt metrics are weaker now than they have been in the past, and are weaker than those of its peers.
This is how long-term debt has grown, or perhaps it would be more appropriate to say spiked:
The company says in its 10-K, “Our long-term business strategy requires capital to open new stores, fund strategic acquisitions, expand distribution infrastructure, operate and maintain existing stores and may include the opportunistic repurchase of shares of our common stock through our Board-approved share repurchase program. The primary sources of our liquidity are funds generated from operations and borrowed under our unsecured revolving credit facility.”
To that end, debt has helped the company grow its revenue, earnings and free cash flow. Let’s start with revenue:
This chart shows the growth of EBITDA (earnings before interest, taxes, depreciation and amortization):
This is how free cash flow has grown:
In a recent commentary on O’Reilly, Adelphi Venture Capital suggests the American dollar will strengthen, given the election results, and that will be good for the company. “Not only will O'Reilly Automotive be safe from currency headwinds due to having its operations wholly within U.S. borders, unlike rival AutoZone (NYSE:AZO) which has approximately 9% of its stores in Mexico, but the company also stands to benefit from lower import costs, thanks to the strong dollar.”
Long-term debt at O’Reilly has dramatically increased, but the company has used it to grow both its revenue and its earnings. At the same time, the company may be poised to further increase its financial edge over at least some competitors because of its domestic focus.
Valuation
O’Reilly Automotive receives 5 out 5 Stars for predictability of earnings increases. That consistency means the company is more likely than most to produce capital gains if held over the medium or long term.
The GuruFocus DCF calculator turns out a valuation of $294.08, which is just a couple of dollars above the 52-week high, and provides a 6% margin of safety over the current price:
The analysts followed by NASDAQ.com have a 12-month consensus target of $302.00, which is 9% higher than the current price. They also have a positive perspective:
While we do not know whether to expect 6%, 9% or something else, we do know its earnings are growing and its share price should follow.
Conclusion
For investors with a bias toward growth stocks, this stock will have a place on their short lists. The company is borrowing and applying much of its cash flow to expanding the company, both organically and through acquisitions.
It is rewarding shareholders with stock buybacks. But with no dividend, it will not be a stock for income investors.
For value investors, the level of long-term debt will take O’Reilly Automotive off the table, despite its many other impressive achievements.
Disclosure: I do not own shares in any of the companies listed in this article, nor do I expect to buy any in the next 72 hours.
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