On Thursday, Sept. 22, AutoZone Inc. (AZO, Financial), one of the big four auto parts retailers, will release its fourth quarter and fiscal 2016 earnings.
With a 5-Star GuruFocus predictability rating and a history of exceptional growth, it is a company worth watching. Especially now that the share price has pulled well back from its 52-week high. But, buying that growth also means buying into a heavy load of long-term debt.
AutoZone currently has a place on the Undervalued Predictable and Buffett-Munger screeners at GuruFocus, and so we investigate whether it should be on the short list of investors who want to invest in auto parts retail or specialty retail.
History
1979: Company founded as Auto Shack by J.R. "Pitt" Hyde III, in Forrest City, Arkansas, a division of Malone & Hyde.
1983: Opens 100th store, in Texas
1986: Spun off as a freestanding company.
1987: Name changed to AutoZone.
1991: Goes public on the New York Stock Exchange, symbol AZO.
1995: Opens its 1,000th store, in Kentucky.
1996: Online debut of AutoZone.com; acquires ALLDATA, a provider of original equipment manufacturer (OEM) automotive repair information and solutions.
1998: First international store opens, in Mexico.
2010: iPhone and Android AutoZone Smartphone Apps are introduced.
2012: Sets up in second international market, Brazil; acquires AutoAnything, an online retailer of specialized automotive products.
2014: Acquires Interamerican Motor Corporation (IMC), a retailer of parts for imported autos.
History from the company website.
Comments: A fast growing company (note it went from 0 to 100 stores in its first four years) through internal growth and acquisitions. Also an early adopter of online technology.
AutoZone’s Business
AZO is a retailer of auto replacement parts and accessories in the United States, Mexico and Brazil. About 90% of those stores are in the U.S., including Puerto Rico (unless otherwise noted, information in this section comes from the company’s 10-K for 2015).
Under that umbrella, the company sells:
- New and remanufactured auto parts, maintenance items, accessories and non-automotive products in its AutoZone stores
- A commercial sales program offering commercial credit and delivery of parts and other products to local, regional and national repair garages, dealers, service stations and public sector accounts.
- ALLDATA brand automotive diagnostic and repair software, through www.alldata.com and www.alldatadiy.com.
- An online store, autozone.com, sells automotive hard parts, maintenance items, accessories and non-automotive
- Another online entity, autoanything.com, sells accessories and performance
- Commercial customers can buy through autozonepro.com and imcparts.net.
The company does not earn revenue from automotive repair or installation services.
It operated 5,692 retail stores, at May 24, 2016 (end of third quarter):
- 5,226 AutoZone stores in the United States, including Puerto Rico;
- 458 stores in Mexico;
- 8 stores in Brazil; and
- 25 Interamerican Motor Corporation (“IMC”) branches (replacement parts for imported autos).
In addition, AutoZone has 4.4-million square feet of distribution facilities.
Customers: AZO serves two distinct markets, the Do-It-Yourself people and the Do-It-For-Me people (images from the March 2016 Investor Presentation):
Comments: A big company with an extensive bricks and mortar footprint, as well as online sites, that sell a wide range of auto parts and accessories to two core groups of buyers.
Revenues
This table from the 10-K for 2015 gives us an idea of how much the company is skewed toward bricks and mortar retail:
In the Annual Letter to Shareholders for 2015, chairman and CEO Bill Rhodes noted, “While this business is growing at a faster pace than our “brick and mortar” business, it remains small in absolute terms. However, over time, as mobile shopping intensifies, it will only expand.”
Comments: The company continues to depend heavily on physical stores for its revenue and leading place in the market; online apparently is important but has yet to make much of a mark.
Competitors
Autozone said in its 10-K that the market is highly competitive, and it faces competition from “…national, regional and local auto parts chains, independently owned parts stores, online parts stores, wholesale distributors, jobbers, repair shops, car washes and auto dealers, in addition to discount and mass merchandise stores, department stores, hardware stores, supermarkets, drugstores, convenience stores, home stores, and other online retailers that sell aftermarket vehicle parts and supplies, chemicals, accessories, tools and maintenance parts.”
Ben Stubel, writing in a GuruFocus article, says there are four major players in the auto parts business, “Advance Auto Parts (AAP, Financial), AutoZone (AZO, Financial), O’Reilly Automotive (ORLY, Financial) and Genuine Parts (GPC, Financial) NAPA.” Thus, we would expect the other three to be AZO’s major competitors.
In addition, Amazon (AMZN, Financial) and other online players want a piece of the market. Strubel, however, calls that wishful thinking, “Right now investors are drawing the right conclusion about the susceptibility of the parts stores to Amazon. Amazon’s logistics network as it is currently configured just isn’t a threat to the bulk of the parts stores business. Additionally the DIY market has always had competition from discount online retailers, and Amazon being another entrant should not have a large impact.”
AutoZone says the main driver of its competitiveness is customer service, which includes the advice of its store employees. Other factors include product quality, selection and availability, price, warranties, store layouts and locations, as well as its brand name, trademarks and service marks.
Comments: AZO operates in a competitive market that includes three other major brick and mortar retailers, as well as Amazon and other online sales sites.
Moat
In the Letter to Shareholders, chairman/CEO Rhodes also said, “Ten years ago, we made a very intentional shift to intensify our focus on leveraging our unique and powerful culture: our single largest point of differentiation.”
A related area of competitive advantage comes from its ongoing inventory management; the company has been able to support staff by ensuring the right inventory is in the right place at the right time.
Size and scale: As the biggest of the big four auto parts companies, it enjoys economies of scale in purchasing and other areas, as well as cross-selling opportunities.
As noted above, it is one area of retailing that Amazon and other online vendors have not yet seriously disrupted.
At SeekingAlpha.com, Bryan Wagman wrote, “From a qualitative perspective, AutoZone is an exceptionally strong company. Its deeply entrenched position of leadership in the auto parts retailing industry, with the aid of exceptional capital allocation from management, has made shareholders very wealthy over the course of the past ten years.”
Comments: The strength of a well-established, well-managed market leader and the lack (so-far, at least) of online competition gives AutoZone a solid moat.
Growth
The company sees eight areas for growth, as outlined in this slide from its March 2016 Investor Presentation:
And, more specifically,
Although the company does not reference acquisitions, I would assume they remain a possibility.
Comments: AutoZone has many different opportunities to grow organically, and growth by acquisition should remain an option going forward.
Other
Fiscal years end on the final Saturday of each August.
The company was incorporated in Nevada, and headquartered in Memphis, Tennessee.
Chairman, president and CEO, William C. Rhodes, III, age 50, has been president, CEO and a director since 2005; became chairman in fiscal 2007. Before joining the company in 1994, Rhodes had been a manager at Ernst & Young LLP.
More than 81,000 employees at the end of fiscal 2015.
Ownership
Ten of the gurus followed by GuruFocus own stock in AutoZone; the biggest holding belongs to Steven Cohen (Trades, Portfolio), with 85,700 shares. Meridian Funds (Trades, Portfolio) and Jim Simons (Trades, Portfolio) hold the second and third largest positions.
This GuruFocus table shows the very large stake that institutional investors have taken in AZO:
Shorts control more than 2.3-million shares, but their interest has declined year-to-date, after rising for several years.
Comments: Very much an institutional stock, with a modest showing by the insiders, and a declining interest among shorts.
AZO by the Numbers
Comments: A stock that obviously hasn’t seen a split lately; the current price is closer to the 52-week low than the 52-week high; the company does not pay a dividend, but it bought back more than 5% of its outstanding shares in fiscal 2015.
Financial Strength
AutoZone gets a meager 4 rating for its financial strength, but a strong 8 for its profitability and growth, in the GuruFocus system:
Why does the system think its financial strength is poor? We find an immediate clue in the first metric and icons: Cash to Debt ratio. GuruFocus notes, “NYSE:AZO's Cash to Debt is ranked lower than 96% of the 943 Companies in the Global Specialty Retail industry.” It’s not the worst in its industry for debt, but close to it.
GuruFocus also issues one medium warning about the debt, along with some reassurance, “AutoZone Inc has been issuing new debt. Over the past 3 years, it issued USD997.221 million of debt. But overall, its debt level is acceptable.”
Here’s another perspective, from Dan Moskowitz at Investopedia.com on Sept. 12, “AutoZone has been taking advantage of prolonged record-low interest rates for years by buying back shares aggressively, which reduced the share count and aided improved earnings-per-share, which then helped boost the stock price. The bad news is that this has led to $9.8 in net debt.”
So, there is a positive side to the growth in debt, but Moskowitz also goes on to point out the downside, “If interest rates move higher, then AutoZone will have a more difficult time paying off that debt as a higher interest expense eats into operating income, which would also have the potential to negatively impact growth.” He adds, “Despite these concerns, UBS sees an opportunity.”
In its 10-K, the company notes, “Proceeds from the issuance of debt in fiscal 2015 were also used for the acquisition of IMC. “
This chart shows the progress of long-term debt (blue line) and Earnings Per Share (EPS) since 1997:
Here’s how AZO’s Debt to Equity ratio compares with those of O’Reilly, Advance and Genuine:
Over that same period, the company has also grown its revenue substantially:
EBITDA has grown:
And, free cash flow has grown:
Comments: The metrics above remind us that AutoZone is a growth stock, a company that has grown both its top and bottom lines. Part of that growth has come from long-term debt, which the company has used strategically, rather than in a rescue sense.
Valuations
AZO receives a perfect mark, a 5-Star (out of a possible 5) rating for predictability. It has grown its EBITDA consistently:
- 5 years: 7.70%
- 10 years: 7.8%
All else being equal, a company with highly consistent earnings, like AutoZone is more likely to deliver strong price appreciation over the next 10 years, and much less likely to lose an investor money.
Looking at more specific valuations, GuruFocus says, “AutoZone Inc is more suitable for Earning Power Based valuation methods. This includes 1) Median P/S Value 2) Peter Lynch Fair Value. The Median P/S Value of AutoZone Inc for today is 550.02. The Peter Lynch Fair Value of AutoZone Inc for today is 578.44.”
Both of these estimates come in well below the Sept. 15 closing price of $739.11. On the other hand, the DCF Fair Value calculator gives us a price that is 31% above the current price:
The P/E ratio currently sits at 18.79, a bit overvalued if we use 15.00 as our reference point. For AZO, though, this represents a pullback from previous heights:
Here’s how AZO’s 18.79 compares with its three big rivals:
- O’Reilly: 27.48
- Genuine: 20.82
- Advance: 24.37
A P/E comparison, then, makes AZO the least expensive of the big four auto parts retailers.
A related measure, the PEG ratio, comes in at 1.06, which puts it at the bottom of the fair-valued range (1.0 to 1.9). Again, its ratio compares favorably with those of its principal competitors:
- O’Reilly: 1.23
- Genuine: 2.35
- Advance: 2.15
Comments: Although AutoZone is not a cheap stock, its valuations compare favorably with those of the other big three auto parts retailers.
Conclusions
When AutoZone Inc. announces its fourth quarter and fiscal 2016 results on Sept. 22, we’ll have a chance to see whether it still deserves its status as an earnings king.
We will also find out whether it keeps its status as the lowest-valued of the big auto parts retailers, and consequently a good candidate for an investor who wants to buy into the sector.
Hanging over all of this, though, is the company’s long-term debt, and the possibility of higher interest rates. While that debt has allowed AutoZone management to keep increasing its earnings and earnings per share, as well as make at least one acquisition, it remains a dragging brake on a muscle car.
Disclosure: I do not own shares in any of the companies listed, nor do I expect to buy any in the foreseeable future.
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