Economy Turns Against Auto Parts Companies With A Vengeance

By Kyle Spencer - November 1, 2012 | Tickers: AAP, AZO, ORLY | 0 Comments

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While sales of new automobiles were plummeting during the Great Recession, AutoZone's (NYSE: AZO) stock was soaring through the roof. Today, we'll take a closer look at AutoZone and gauge the strengths, weaknesses, opportunities, and threats confronting the company going forward.

Detroit's near-death experience was the best thing that ever happened to AutoZone. In periods of rapidly declining economic conditions, both retail and commercial customers may defer vehicle maintenance or repair. The credit squeeze, looming recession and high gas prices forcing U.S. to cut sharply back on big ticket items. That resulted in a wave of business expansion for this Memphis, Tenn., based company.

When American motorists cut non-essential travel in response to $4 gasoline, triggering a sudden collapse in demand that had even the mullahs in Iran biting their nails, Autozone benefited even further. That's because the two statistics with the closest correlation to AutoZone's growth are miles driven and the number of seven-year-old or older vehicles on the road.

Strengths

• America's fleet of automobiles is rapidly aging. There were more than 245 million vehicles on U.S. roads in the first quarter of 2012. If you were to pick any five at random, they'd have an average age of 11 years. (7+ is the magic number for AutoZone's bottom line.) These vehicles are no longer under manufacturer's warranties and tend to need more maintenance and repair than newer vehicles.
• AutoZone has strong brand recognition and marketing, with more than 5,000 stores in 49 U.S. states – including Alaska – and 321 stores in Mexico. Autozone also has an extensive advertising campaign in place that encompasses both local and national T.V., FM and A.M. Talk Radio media markets, as well as online advertising, and even billboards.
• The company boasts a mature and seasoned sales force.
• Commercial programs in over 3,000 AZO stores. Originally established in 1996, AutoZone's Commercial department works directly with local automotive repair shops to supply parts for third-party repair orders. 
• The industry is experiencing the impact of lower inflation in some key seasonal categories like air conditioning, and the absence of escalating oil prices has allowed AutoZone to price its oil-related products competitively.

Weaknesses

• AutoZone's sales are falling off -- and worse yet, the company's management doesn't seem know why. Managers suspect adverse weather conditions (automobiles tend to break down more often during bad winters), but at present, the company's number-crunchers can find no statistically significant connection between the loss of sales and the weather. The most ominous reason would be a lack of consumer discretionary income, or the purchase of newer cars, which are cheaper to maintain and break down much less frequently. Whatever the cause, AutoZone's store sales are beginning to stall. 
• High gas prices also impact customer's pocket books, and therefore, their ability to regularly maintain their vehicles.
• The rising cost of insurance, including medical, worker's comp, auto and general liabilities is also a material headwind for the company.
• New car sales are rebounding in the U.S. – especially for Chrysler – even while they continue to fall off a cliff in Europe. If AutoZone had a truly global presence, the one event would naturally offset the other. Unfortunately, AutoZone has no real European penetration. Newer cars pose a serious problem for Autozone, since they're usually under warranty, and require dealership repairs and parts.
• The complexity of newer models prohibits the average person from doing anything but the most basic repairs. Many if not most of these vehicles require electrical or specialized computer diagnostics, which AutoZone is unable to provide at this time. Even then, some of those repairs aren't so basic anymore.

Opportunities

• The company boasts increasing parts hubs and commercial programs. The 18 additional hubs which are now fully operational, which allows AutoZone to expand the number of SKUs (different parts) offered on a same-day basis to its customers.
• AutoZone's Duralast brand continues to gain traction with the company's commercial customers.
• AutoZone's making first its overtures to European market. The general collapse of retail car and truck sales in Europe provides an opportunity for AutoZone to repeat it's blockbuster performance following the collapse of the U.S. auto industry crisis of 2008-2010.

Threats/Risks

• The company operates in a highly fragmented market.
• AutoZone is under increasing competition from supercenters such as Wal-Mart and Costco.
• Rising costs in commodity-dependent products are currently being passed onto customers. This strategy cannot last forever.

Competition

AutoZone's primary competition is Advance Auto Parts (NYSE: AAP) and O'Reilly Automotive (NASDAQ: ORLY). However, both companies are currently facing even greater headwinds than AutoZone. The weakness of AutoZone's competitors is perhaps AutoZone's greatest strength at the moment.

Advance Auto Parts is experiencing a significant near term slowdown on weak consumer demand in both its DIY and Commercial operations, as well as the high gas prices. Advance is also suffering from unfavorable vendor pricing, which is beginning to hamper the companies ability to meet the demands of some of its customers.

O'Reilly Auto Parts is enduring the same adverse market conditions, alongside business decisions by its executives that have not been in the best interest of the company's stockholders. A recent company stock buyback inflated O'Reilly's share price, even as company insiders sold large blocks of their own shares. In this Fool's opinion, that move calls the integrity of O'Reilly's management into question.

Foolish Takeaway

AutoZone is the best of a bad breed. Despite the company's debt overhang from repeated stock repurchases, the company's fundamentals are so strong that it's a shame I can't recommend AutoZone – or indeed, any other other auto parts stock -- as an investment at this time. The companies have already pared staff down to skeleton crews, and there is nothing left to cut.

Should AutoZone successfully penetrate the European market, a resurgence in the stock would swiftly follow. But with industry fundamentals currently deteriorating with the broader market, I must recommend a SELL rating on AutoZone, Advance Auto Parts and O'Reilly Auto Parts at this time. 

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