Editor's Choice

Why Buying This Company’s Peers Makes More Sense

Harsh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The U.S. auto industry has done pretty well so far this year. Sales of new cars have gained strength, although there was a temporary slip in April when sales slowed down a bit, but they were still strong nevertheless. However, shares of aftermarket retailers have done tremendously well even though new car sales might be picking up, with Advance Auto Parts (NYSE: AAP), AutoZone (NYSE: AZO), and O'Reilly Automotive (NASDAQ: ORLY) all up more than 20% this year.

The sector’s strength was on display earlier this week when AutoZone released impressive third-quarter results and its shares jumped close to 4.6%. The company benefited from a normal winter as opposed to a milder one last year and expects to enjoy its benefits going forward.

AutoZone’s revving it up

More importantly, the headwinds which AutoZone faced in the previous quarter were less severe on a sequential basis. The company’s same-store sales were down 0.1%, but were better than the drop of 1.8% seen in the second quarter. Revenue of $2.21 billion was 4.5% higher than last year and earnings of $265.6 million, or $7.27 per share, were also up almost 7% as compared to the prior-year period.

AutoZone expects further improvements going forward as it looks to make its business more efficient. The company has been remodeling and opening new hubs, while also focusing on the experience it provides to customers through its “Great People Providing Great Service!” initiative. Also, AutoZone’s ecommerce business seems to be doing well as it improved 80% from last year, driven by the acquisition of AutoAnything in the previous quarter.

Moreover, the company is counting on lower gas prices, the high average age of vehicles in the U.S., and customers looking to bring out the maximum from their older vehicles. AutoZone also sees huge opportunity in the commercial market as only 68% of its domestic stores run a commercial program. It expects its commercial business to grow at a good pace and this should further contribute to revenue going forward.

In addition, the company is looking to open around 300 stores this year and further strengthen its position as the largest auto-parts retailer in the U.S.

Decent valuation…

However, the most important question right now is whether AutoZone is a buy at these levels. The stock has had a very nice run this year and now trades at almost 17 times trailing earnings. But, a forward P/E of 13.5 indicates that earnings growth is on the way, and the company’s share repurchase program would be playing an important role in this growth.

When stacked up against peers, AutoZone is trading at par with Advance Auto’s trailing P/E of 16.6 but cheaper than O’Reilly’s trailing P/E of 22. Also, AutoZone sports the lowest PEG ratio of the lot of 1.02, while Advance Auto and O’Reilly have PEG ratios of 1.39 and 1.19, respectively. Hence, even the valuation looks good thus far, but things get murkier when you look at the debt.

…but peers are better off

AutoZone has $4 billion in debt on its balance sheet while total cash is around $130 million. The debt is actually $395 million higher than the year-ago period and the company seems to be content buying back shares in order to push up its earnings with the operating cash flow it generates. AutoZone generated $385 million in operating cash flow in the previous quarter and repurchased shares worth $325 million.

In comparison, both Advance Auto and O’Reilly are better off. Advance Auto’s debt is around $614 million while it has cash of around $600 million. Similarly, O’Reilly, which is growing at the fastest rate of the lot, has $1.1 billion in debt but its solid operating cash flow of around $1 billion in comparison doesn’t make the debt level look dangerous.

From a business perspective as well, I believe both Advance Auto and O’Reilly could be better investments. O’Reilly is the only one of the pack which boasts of a positive same-store sales figure and expects growth of 3% to 5% in same-store sales this year. The company is rapidly expanding its store count and it won’t be surprising if it continues outperforming its peers going forward.

Advance Auto is also ticking the right boxes as it is focusing on strengthening its ecommerce business and improving its commercial business. And most importantly, it isn’t as expensive as O’Reilly and its balance sheet isn’t loaded with debt like AutoZone either.

The takeaway

Thus, while AutoZone’s latest results look good and are indicative of the industry’s strength, I believe that investors would be better off buying its peers listed above. AutoZone might appreciate going forward, but if better alternatives such as Advance Auto and O’Reilly Automotive are present, I think it would be prudent to put your money in them rather than a debt-laden company which is focusing more on buybacks rather than repaying its debt.

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Harsh Chauhan has no position in any stocks mentioned. The Motley Fool owns shares of O'Reilly Automotive. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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