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Michael Francis

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AZO AT A GLANCE

P/E ► 11.7 LOW EV/EBITDA ► 7.68 AVG ROA ► 15.6% HIGH ROE ► 323.7% VERY HIGH Debt to Equity ► -12.1   Current Ratio ► 0.934 LOW Interest Coverage Ratio ► 8.12 AVG

 

 

 

 

 

 

AutoZone (NYSE:AZO) is the largest U.S. retailer of automotive parts and accessories to do-it-yourself (DIY) customers by number of stores. During FY 2009, AutoZone operated over 4,000 stores, the majority (96%) of which are in the United States and Puerto Rico.^[1] The company places stores in regions that have large number of vehicles seven years old and older because of these cars’ need for repairs and maintenance. While the company seeks to open stores in high-traffic areas, AutoZone is largely a destination retailer - a retailer that generates its own traffic instead of relying on other nearby stores’ traffic base.^[2]

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); fewer auto parts manufacturers reduces the pricing power the company enjoys as the largest auto parts retailer in the U.S. because the company now has fewer suppliers to choose form. 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.

Business and Financial Metrics

When people buy fewer cars, they repair their old ones more often. Notice that O’Reilly Auto Parts’ share price moved up over 70% between July 2008 and July 2009. The financial situation of Auto-Zone for the past year has been similarly positive, but is subject to risk as explained below and elaborated upon in the Trends and Forces section.

The 10 year net margin chart to the right alludes to AutoZone’s profitability. The margins have stopped growing and have leveled off, which shows that AutoZone’s core business model is stable in the 1 year time horizon at the very least. The advent new car technologies (electric or hydrogen fueled vehicles) may change AutoZone’s profitability over time, but it is difficult to say how without having seen critical adoption of any such auto-innovation.

Looking at Wikinvest's Operating Metrics ^[3] for the number of stores Autozone has been from year to year the primary industry player, though O'Reilly Automotive (ORLY) is quickly catching up. Also, the aggregate number of auto-repair stores is increasing. This makes sense, because fewer people are buying new cars and more people are looking to repair their old cars. Once people start buying new cars again, however, the aggregate effect will be an excess of auto-repair shops. This will increase competition over time and cause industry margins to lower, possibly damaging the profitability of Autozone depending on how it fares in this new competitive environment.

It is also important to note that Autozone has retired a large portion of its financing expenses. The impact on Autozone's cash flows is depicted on the Autozone Cash Flow page. ^[3]

AutoZone rode the boost to the auto-repair industry in order to implement a large share buyback. ^[4]

Investors can either view a share buyback as a sign of confidence in the corporate board, or a bluff (companies sometimes buy back shares to artificially increase their stock price so the management can exercise their stock options). The market responded positively to the share buyback which supports the view that Autozone’s confidence is justified. Despite the company’s confidence, the market does give Autozone a significantly lower P/E ratio than it does to O'Reilly Automotive (ORLY) and Advance Auto Parts (AAP) . Looking at the operating metrics pages for AutoZone (AZO) , O'Reilly Automotive (ORLY) and Advance Auto Parts (AAP) (the three big auto parts companies) one will notice that they are quite similar except for the growth rates, for which O’Reilly is dominating. This could be explained by any number of qualitative factors such as superior customer service, better marketing, or faster turnaround.

Q4 2009 Summary

The total net sales in the fourth quarter of FY2009 were $2.2 billion, an increase of 1.0% compared to fiscal fourth quarter of FY2008.^[5] Autozone Chairman, President, and CEO Bill Rhodes stated that the increase in total net sales for the fourth reporting quarter was primarily due an expansion in parts assortment and increasing the number of stores in its Hub store model.^[6] For example, in the fourth quarter, Autozone opened 58 new stores in the U.S. and opened 20 stores in Mexico.^[5] As of August 29, 2009, Autozone had 4,229 stores in the U.S., and 188 stores in Mexico.^[5]

In the fourth quarter of FY2009, Autozone also repurchased 3.8 million shares of the company's common stock for $587 million, at an average price of $154 per share.^[5]

Q1 FY2010 Summary

Despite slowing sales growth, AutoZone was able to post a 9.1% rise in profit, or $143.3 million, for its fiscal first quarter.^[7] AZO attributes this rise in profit to lowered gas prices which helped the company increase sales in the fourth quarter of FY2009.

Furthermore, consumers in the auto industry are particularly price sensitive during recessions as it is easier to delay purchase of vehicles than more price insensitive products such as groceries. As a result, consumers purchase car repair parts to fix current cars in place of purchasing new vehicles. This situation has therefore AZO to benefit, and has contributed largely to its profit increase this fiscal quarter. Domestic same-store sales therefore rose over 5%.^[8]

Autozone was also able to commit its earnings to expansion throughout this period. In the three months up-to November 1, 2009, AZO opened 38 new stores in the U.S. and 5 in Mexico. ^[9] Furthermore, under AZO's share repurchase program, the company repurchased 1.4 million shares of its common stock for $204 million during the first reporting quarter.^[10] Despite such positive growth, AZO's growth in sales is largely based on the temporary fix-it trend given the current economic trend; therefore, as economic factors stabilize, it is questionable whether individuals will continue to choose to fix old vehicles in place of purchasing new ones.

Key Trends and Forces

O'Reilly Automotive (ORLY)'s explosive expansion could lower Autozone's margins

O'Reilly Automotive (ORLY) grew its number of stores by 79% this year (from 1,830 to 3,290). While Autozone still has 4,290 stores, it grew only 4% this year despite favorable economic tailwinds. This means lower margins for AutoZone (AZO) for two reasons:

1. Lower pricing power. More stores means more competition. More competition means that customers can bargain for lower repair prices. This will be exacerbated when the economy picks back up because new cars will need fewer repairs, driving demand down lower along with margins.
2. Higher variable expenses. In an attempt to keep a higher price point, all parties will try to differentiate themselves with better service, new initiatives (like servicing Electric Cars), and faster turnaround time. As the cost structure increases, margins will decrease.

One way to counter this trend is AutoZone's position in Mexican markets. From the period between July 2004 and July 2009, the index of Mexican stocks, the IShares MSCI Mexico Index Fund (EWW) denominated in dollars has outperformed the S&P 500 by over 100%. As the Mexican economy picks up, and its middle class grows, so will its demand for automobiles and therefore automobile repairs. AutoZone (AZO) has over 150 stores in Mexico currently so is ideally positioned to take part in this trend.

The development of Hybrid and Fuel Cell Vehicles and Electric Cars will provide both risk and opportunity for Autozone

As the basic mechanics of cars changes, Autozone will need to train its employees and buy new equipment. The changing landscape of cars will inevitably provide opportunities for new entry. Autozone's favorable Economies of scale will be less significant in a changing market and add business risk. At the same time, its superior capital basis and market capitalization could give it the resources to adapt. When mass adoption of new automobile technology begins in full, watch how well Autozone deals with the change in comparison with its competitors.

At the same time, 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.^[11] 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.

Rising Oil Prices May Lead to Less Driving, Less Repairs

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.

Also, when individuals are capital constrained because of the recession, they repair their old cars instead of buying new ones. If demand for automobiles picks back up, then old cars will get sent to the junkyard instead of boosting AutoZone (AZO) revenue figures.

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.^[12]. 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.

Footnotes

1. ↑ AZO 2008 10K  
2. ↑ From 2007 Annual Report, pg 6-7
3. ↑ ^{3.0 3.1} Wikinvest AZO Operating Metrics.
4. ↑ AZO Share Buyback.
5. ↑ ^{5.0 5.1 5.2 5.3} Same Store Sales Up 5.4%; AutoZone 4th Quarter EPS $4.43
6. ↑ AutoZone Same Store Sales Are Up 5.4 Percent
7. ↑ AutoZone Profit Rises 9.1%
8. ↑ AutoZone drives through analyst expectations in Q1
9. ↑ 9% Rise Reported by AutoZone in First Quarter Earnings
10. ↑ AutoZone 1st Quarter Sales Increase 7.5%; EPS Increases 26.4% to $2.82
11. ↑ AZO Annual Report, “Risk Factors,” pg 12
12. ↑ 2006 Automotive Aftermarket Industry Association (AAIA) Report