On Dec. 15, AutoZone Inc (AZO, Financial) authorized an additional $1.5 billion for share buybacks, signaling its confidence in the company's future.
Should investors share that confidence?
In its most recent 10-K filing, for the year that ended Aug. 29, 2020, it described itself as "the leading retailer, and a leading distributor, of automotive replacement parts and accessories in the Americas."
At fiscal year-end, it operated 5,885 stores in the U.S., 621 stores in Mexico and 43 in Brazil. Those stores carry new and remanufactured parts for cars, utility vehicles, vans and light trucks.
Most of the stores also have a commercial sales program that deals with repair garages, auto dealers, service stations and public sector accounts. In addition, it sells auto diagnostic and repair software and sells through its own online portal.
AutoZone also reported that it operates in a highly competitive market, driven by factors such as name recognition, product availability, customer service, store location and price. It added the aftermarket parts industry competes in two main segments, retail DIY (do-it-yourself) and DIFM (commercial do-it-for-me).
There are four big auto parts chains, including AutoZone (annual revenue: $12,993.190); its three biggest competitors (and their annual revenues) are:
- O'Reilly Automotive Inc (ORLY, Financial): $11,258.70
- Genuine Parts Co (GPC, Financial): $18,902.81
- Advance Auto Parts Inc (AAP, Financial): $9,853.80.
What's ahead for the industry? According to Grand View Research, it is modest growth,
"The global automotive aftermarket size was valued at USD 378.4 billion in 2019 and is expected to grow at a compound annual growth rate (CAGR) of 4.0% from 2020 to 2027. The market is majorly driven by the pursuit of automobile drivers to enhance their vehicle performance in terms of exhaust sound, speed, appearance, along with other aspects."
If past is prologue, AutoZone may be able to beat that growth rate; see the three-year growth rates for revenue, Ebitda and earnings per share at the bottom of the profitability table:
Over the past 10 years, the average earnings per share growth rate was 15.60% annually. That's consistent with growth of the share price over the same period:
Whether we talk about earnings growth at 4% or 15.6%, the odds are good that shareholders should see similar share price increases over the next decade.
One of the keys to that kind of growth is the amount of free cash flow available to pour into growth initiatives, to lease or buy land, build and stock stores, to train staff and so on. This 10-year chart shows a distinct improvement in recent years:
AutoZone also has the financial strength to keep growing at a faster rate than the industry:
The low ranking, 4 out of 10, derives mainly from its debt situation; for example, its cash-to-debt ratio is just 0.2. That's weaker than the retail-cyclical industry's 10-year median of 0.52 and its own 10-year median.
The Piotroski F-Score is reasonable, while the Altman Z-Score is in what is called the "gray" area, suggesting fiscal stress.
The bright spot on this table is the difference between what the company pays, on average, for its capital and what it earns from it. It's a lopsided relationship on the positive side. The weighted average cost of capital is 5.3%, while the return on invested capital comes in at 25.11%. Management has allocated its capital well.
Going back to the profitability table, AutoZone has strong margins; 19.49% for its operating margin and 14.05% for the net margin. Both are ahead of the industry and its own history, and suggest a competitive advantage or moat.
AutoZone does not pay a dividend, but it has rewarded shareholders by buying back its own shares quite consistently and will continue in 2021, as we saw above. The net result of its repurchases over the past decade is that earnings are being shared among fewer and fewer shareholders:
According to the chart, the share count reduction has averaged 7.10% per year.
The metrics offer three levels of valuation: modestly overvalued, fairly valued or modestly undervalued. Starting with the GuruFocus Value chart, we get a fair valuation:
The price-earnings ratio is low compared to the 10-year industry median, 15.45 versus 22.12, while it's not far off its own 10-year median of 16.57.
The PEG ratio suggests modest overvaluation, a ratio of 1.51 where fair value is pegged at 1.
The undervaluation comes from the discounted cash flow calculator, which is based on a solid 4.5 out of five-star predictability rating:
Turning to risk, when I first wrote about AutoZone in 2016, there was concern about Amazon.com (AMZN, Financial) disrupting the auto parts business as it has disrupted so many other retail sectors, but that hasn't happened so far.
In a briefing to subscribers in 2017, Business Insider reported Amazon had made deals with several big auto parts suppliers that would allow them to sell their products directly through Amazon.
AutoZone appears to be joining, rather than fighting. A quick online search turns up AutoZone as an Amazon vendor. Further, a CNBC article noted that AutoZone is maintaining an edge with its extensive variety of inventory and especially its customer service:
"Store staff are trained to help customers avoid highly risky mistakes — such as choosing the wrong type of brake pad. They are even known to help with some installation work, like fitting new wipers on a windshield.
"That kind of personalized customer service is difficult for online competitors, and even large retailers like Walmart, to imitate."
Generally, the gurus like what they have been seeing, as shown in this chart of buying and selling volumes:
The three biggest stakes among the 10 gurus with positions are those of:
- Tweedy Browne (Trades, Portfolio), which cut its holding by 4.67% in the third quarter to finish with 94,090 shares. That represents a 0.41% stake in AutoZone and consumes 4.30% of its portfolio (while the numbers of shares held by the gurus are relatively low, each share is also relatively expensive, $1177.91 near the close of trading on Dec. 31).
- Jim Simons (Trades, Portfolio)' Renaissance Technologies with 84,100 shares, a new holding for the firm.
- Steven Cohen (Trades, Portfolio) of Point72 Asset Management, who reduced his holding by 59.73% to 38,940 shares.
Conclusion
Yes, we should have confidence in AutoZone. The auto parts retailer is continuing its successful growth, with the key metrics in place to fund growth and return some value to shareholders with share buybacks. It is meeting the challenge of online retailing in its own ways, maintaining its profitability.
Valuation depends on your tool of choice; most of us would probably put it around fair valuation. There is limited interest from the gurus, with the biggest stake being less than 1% of AutoZone's capitalization.
Value investors will like the undervaluation, such as it is, too shallow for their liking, but might take interest when the stock price dips again. Growth investors who take a longer view might find the current price reasonable. Nothing here, though, for income investors.
Disclosure: I do not own shares in any of the companies named in this article and do expect to buy any in the next 72 hours.
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