Why AutoZone May Still be a Bargain
Damon is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Do-it-yourself auto parts retailer AutoZone (NYSE: AZO) has seen its shares climb about 18% in 2012 as earnings continue to reach record heights. But what is in store for the company after this year? The answer is likely much of the same as far as profit growth is concerned, depending on a few factors. Accordingly, one may view it favorably in light of a strategy that has ignited such rapid earnings expansion over the past decade.
Able to Weather any Economic Conditions
One aspect of the industry where AutoZone resides is its reliance on a significant number of aged vehicles on the road. In fact, management refers to OKVs, short for “our kind of vehicles,” meaning those that are seven years old or older. It also, of course, offers a less expensive substitute for auto mechanics. As a result, when the domestic economy is struggling, these aspects of the business help it to more than overcome the slowdown. The numbers back this up: as unemployment rose, so did AutoZone’s comparable-store sales comparisons. On the other hand, if GDP is increasing, consumer sales of discretionary offerings tend to gain ground and demand for failure and maintenance products may not be as robust. In addition to new auto sales, the bottom line may be impacted by gasoline prices and their effect on miles driven.
Overall, AZO has been racking up comps that peaked at 6.3% year over year in 2011, then dipped back somewhat in fiscal 2012. It appears to be capturing market share from core competitors including Pep Boys (NYSE: PBY). PBY recorded a slight decline in that metric last year, despite a modestly improved performance from its service business. Its comps have only been about break even versus 2011 this year, too, though net income is on the mend.
Ongoing Store Expansion
AutoZone stores are being built at a rate of approximately 4% annually. Management sets a target return on invested capital for each new unit, a plan that has supported an overall jump in that measure from 24% in 2008, to 33% this year. Importantly, sales per square foot have improved as well, thanks to merchandising initiatives that have enhanced the supply chain, upping the probability that a part will be on the shelves. Employee training has been key to this higher ticket, also. AZO’s sales acceleration is also substantially attributable to the increased contribution of its commercial delivery program.
With only a minuscule share of that market, it has now extended the service to more than 60% of its store base. Of late, commercial same-store sales have climbed faster than the total top line. The downside to this business is its lower gross margins. In looking at Advance Auto Parts (NYSE: AAP), where roughly 90% of stores offered commercial sales at the end of 2011, those revenues are growing faster. Like AZO, it is bolstering the selection of its commercial unit. Its goal is to lift its proportion of those sales to 50%, from 34%. And, interestingly, Advance’s margins had been widening, supporting earnings gains up until very recently.
Buying back a significant percentage of its common stock each year has allowed AZO’s earnings per share to rise tremendously. Since 2010, the company has repurchased another 19% of shares. At the same time, it has amassed considerable long-term borrowings, lifting interest costs. Nevertheless, management aims to maintain an investment grade credit rating, too. Notably, Advance has also repurchased large amounts of stock in recent years, boosting share earnings greatly.
AutoZone’s business model and expansion initiatives should allow for further income growth. In particular, the potential for commercial sales gains remains sizable. While bottom line increases are likely to retreat from the 20% to 30% levels of the past several years, the outlook is bright. AZO stock is trading near its historical average of around a 12 P/E, and could entice risk-tolerant investors.
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