Where Next for the Auto Companies?
Lee is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The auto parts sector has been one of the strongest performers in the market over the last few years. The investment thesis behind it is that as the slow economy causes drivers to keep their cars on the road longer the average is going up. This is great news for the cash registers of AutoZone (NYSE: AZO) and O’Reilly Automotive (NASDAQ: ORLY) because older cars require more servicing and therefore more parts. The thesis has been working, but will it continue to do so?
Auto Parts Sector Dynamics
There are a few moving parts to the answer to the question I posed above.
First, there is the question of industry capacity. Obviously capacity is related to ongoing end demand but I want to focus the fact that all the auto parts companies have been expanding store roll outs in order to chase volumes. If we look across the industry at AutoZone, O’Reilly and Advance Auto Parts (NYSE: AAP) we can see that same stores sales growth is slowing. Incidentally, I’ve adjusted the others results to the comparable period for AutoZone.
The de-acceleration is noticeable and let’s recall that there was some pull forward in activity in the previous quarter. It looks like we are reaching the stage where industry growth is starting to be constrained.
The second factor is the age of an old car in the US. The latest data (Jan 2012) suggests that this metric remains very favorable to the auto parts retailers.
However US new car sales have been very strong this year. According to Kelley Blue Book new car sales in August jumped 18.7% from last year. I think that a combination of an improved economy plus the need for car replacement is going to start taking down the average age of the US car.
Ford Motor Company (NYSE: F) stock may be performing badly this year, but that has more to do with European car sales hitting historic lows. In the US, Ford’s auto sales were up 13% in August alone. Ford’s problem is that it is heavily exposed to Europe and its sales there were reported as being down 29% in August alone. Ouch! Unfortunately, Ford isn't a good way to play booming US car sales.
The third factor is car miles driven. This is a function of the overall economy and gasoline prices. Many think it is price inelastic, but the truth is that this metric has reached a plateau in recent years and this suggests that driver behavior has adjusted to higher gasoline prices. If it continues then this is a net negative for the car parts retailers.
Putting these three factors together rather suggests the sector has had its heyday and could be set for some moderation in growth going forward.
AutoZone’s Latest Results
The key point take way from AutoZone’s results was the weak same store sales growth, but this was pretty much anticipated by the market. In addition the company admitted it had hoped for more out of the quarter. The big imponderable here is how much of this is weather related? The mild winter in the US meant that many cars were not as stressed as they might have been and AutoZone argued that this could be the case for the industry wide slowing in same store sales growth.
I would normally give management the benefit of the doubt, but in this case I am skeptical. It is too much of a coincidence for me that new car sales are surging this year and suddenly the auto parts retailers metrics start to look less strong. For example, if new sales are being driven by a replenishment cycle then it is precisely the sort of high maintenance jalopies which are being taken out of service first. Those jalopies are AutoZone’s bread and butter sales generators.
Where Next for the Auto Parts Companies?
The sector hasn’t really done much in recent months as the market anticipated the weaker numbers, but the question is how will things look going forward? I think the outlook is not as strong as it's been for a while here and I wouldn’t get too excited about buying into the sector.
With that said, a key point needs to be outlined. These stocks offer counter cyclical growth prospects and investors looking for true diversification should be interested in holding such stocks in their portfolio. If we do move into a double dip scenario, these stocks will relatively outperform.
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SaintGermain has no positions in the stocks mentioned above. The Motley Fool owns shares of Ford. Motley Fool newsletter services recommend Ford. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.