AutoZone (AZO)

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AutoZone is the largest U.S. retailer of automotive parts and accessories to do-it-yourself (DIY) customers. Founded in 1979, the company operates over 4,000 stores, the vast majority (97%) of which are in the United States and Puerto Rico. The company targets demographic regions in which they estimate there to exist a large number of vehicles seven years and older, mostly given these cars’ propensity for repairs and maintenance. While the company seeks to open stores in high-traffic areas, AutoZone is largely a destination retailer, which generates its own traffic instead of relying on other, nearby stores’ traffic base.^[1]

Operating in a mature and fragmented marketplace, AutoZone’s growth has been largely dependent upon increases in store count rather than its same store sales which have been lagging over the past 5 years. In addition, Autozone has been facing pressure in a consolidating auto parts manufacturer industry (related to the woes of the Big Three automakers), which in turn decreases the company's pricing power it enjoys as the largest auto parts retailer in the U.S. Finally, in the longer term, the company may see decreased demand in auto parts due to continually rising oil prices, which could decrease the mileage driven by American and thus decrease the demand for car repairs and maintenance.

[edit] Financials

Below are revenue and operating profit figures, as well as store metrics for AutoZone. Top line growth has been 2.4% compounded. However, note that sales per store, and sales per square foot have declined each year.

Despite declining store sales efficiency, the company has generated substantial and growing free cash flow ($670 million in fiscal 2007) and high returns on capital (around 22%) ^[4]. It has also bolstered its earnings per share via major stock repurchase programs.

[edit] Trends and Risks

• The automotive aftermarket for parts has steadily, albeit modestly, increasing demand. In the US, increases in the number and age of vehicles, number of miles driven annually, licensed drivers, and total number of light trucks (which generally require greater upkeep) provide for a relatively steady and growing automotive parts market.^[5] The market, however, is mature and unlikely to experience significantly higher rates of growth. Also, increases in the quality of cars may offset the need for secondary purchases of repair equipment and parts.

• AZO has been experiencing limited sales and store growth. The company operates in a domestically mature and fragmented auto parts market, and growth has been quite modest recently and driven almost entirely by new store openings, as opposed to same store sales. The company will have to find new markets that match its demographic and vehicle profile in order to continue growing. It has been expanding its small store base in Mexico, and can benefit from that country’s growth, though its largest market, the U.S., is more highly saturated.

• Compared to competitors, AutoZone operates in only one segment of the autoparts industry (DIY). AutoZone is the largest U.S. retailer of automotive parts but it operates only in the mature DIY (do-it-yourself) market gives the company less room for market share growth unless they were to expand their focus to the DIFM (do-it-for-me) market, which has already established competitors such as O'Reilly Automotive (ORLY) and Advance Auto Parts (AAP).

• AZO's suppliers have been experiencing a wave of consolidation. Auto part manufacturers, which operate in a generally troubled industry, have been consolidating via mergers in recent years.^[6] A more concentrated vendor base for auto part retailers, then, limits the number of companies that the firm can purchase inventory from, and may provide suppliers with greater pricing power, putting pressure on AZO’s margins.

• Oil Prices continue to rise. As oil prices continue to increase, drivers may begin to purchase newer, more fuel efficient vehicles, including hybrid and fuel cell vehicles and/or limit their driving mileage. Greater numbers of new car purchases and fewer drivers accumulating heavy mileage mean that consumer demand for repairs and new parts may be hampered, thus diminishing AZO's sales.

• Uses of cash and heavier debt loads. AZO generates substantial free cash flow, and has used this and its increased debt load to re-invest in itself via share repurchases. The company has purchased more than half of its shares over the past 10 years while increasing its debt load from $545 million to nearly $2 billion today. The debt-laden capital structure makes the firm riskier and levers its operations. If the firm cannot sustain its strong cash flow, there is a chance that it may run into liquidity problems.

[edit] Competition and Market Share

The do-it-yourself (DIY) auto-part aftermarket retailer industry is a highly competitive and generally fragmented $35 billion/year market.^[7]. Companies compete on a mix of customer service, product selection, price, and location.

AZO competes with other major do-it-yourself retailers, like Advance Auto Parts (AAP) , O'Reilly Automotive (ORLY) , CSK Auto (CAO), Pep Boys-Manny, Moe & Jack (PBY), and AutoNation (AN). It also competes with a highly fragmented base of small, single store mom-and-pop shops and do-it-yourself repair destinations, and indirectly with full-service mechanics and other automotive destinations that sell parts or repair vehicles.

[edit] Auto Parts DIY Segment: Operating Metrics & Market Share

Below is a comparison of major operating metrics for the company’s DIY segment as compared to other companies' DIY breakouts:

^[9]

^All sales and market share figures an estimate based on DIY business only

^^Note: PBY, ORLY, and AAP Sales figures excludes service and DIFM revenue, isolating DIY parts sales.

[edit] Footnotes

1. ↑ From 2007 Annual Report, pg 6-7
2. ↑ From 2007 Annual Report, pg 16
3. ↑ From 2007 Annual Report, pg 16
4. ↑ AZO Annual Report 2007, pg 16
5. ↑ CSK Annual Report 2006, pg 9
6. ↑ AZO Annual Report, “Risk Factors,” pg 12
7. ↑ 2006 Automotive Aftermarket Industry Association (AAIA) Report
8. ↑ Market Share calculated as Company Sales/Total Industry Segment Sales nationwide as provided by 2006 AAIA Report
9. ↑ Figures compiled from ORLY, AZO, AAP, CAO, and PBY 2006 Annual Reports