ORLY - O'Reilly Automotive: How To Trade This Winner After We Doubled

Summary

• We have now just about doubled our member's money on this one, O'Reilly Automotive, Inc., and suggest backing the initial investment out plus some profit while letting house money run indefinitely.
• O'Reilly Automotive's Q3 performance was strong, led by very high comps.
• Margin compression was the only stain on O'Reilly's quarter.
• We expect mid-single-digit comps to continue, along with 50%-plus margins, and when coupled with the buybacks, see EPS growing as high as $40 next year, but at least to $35.

We have been bullish on O'Reilly Automotive, Inc. ( ORLY ) for two years, and from our last buy call, we have now just about doubled our member's money on this one. This remains a name we really like. While it had some brief bouts of selling with the market chaos this year, 2022 has largely been decent for this stock.

If we go back to 2020, recall that the stock got slammed during the COVID-19 crisis. Like so many stocks, there was a strong recovery in share prices. Unlike many stocks this year, O'Reilly is now at a 52-week-high. It is a winner. The winning results stem from targeted expansion, smart inventory policies, a focus on margins, extreme levels of share repurchases, and most importantly, great management. Our price target for this stock next year is $1,000.

Make no mistake, the stock trades much like competitor AutoZone, Inc. ( AZO ), and really the path to victory has been similar for both companies. We believe that the growth offered by O'Reilly, as well as the fact that its business is relatively recession-resistant, is a plus. With very high rates, we expect new car sales to slow, so that means cars will be on the road longer, and it bodes well for names like O'Reilly.

We recommend our members now sell enough to take out their entire initial investment, plus 20% profit, and let the rest run forever and ever. You will get any and all upside, dividends, spinoffs, etc. By doing this, you are playing with the house's money. This is the path we have put countless investors on. A path to long-term wealth creation through trading and investing. We think you stick with the stock if you are new to it.

New money should wait for sub-$800 to buy. But long-term, management is doing everything right here. The company continues with its solid buyback, which ensures additional earnings per share growth over time, on top of the organic growth. Let us discuss.

O'Reilly's Q3 performance

O'Reilly just put out its Q3 report . In our opinion, the post-earnings rally so far has been driven by an absolutely stunning performance. This quarter was superb. There is no doubt about it, but what is even more exciting is that performance looks set to continue to be strong long-term. There will be ups and downs in share prices, and in the markets, but this stock is going higher longer term.

The company has solid gross margins and phenomenal comparable sales growth. The company crushed sales expectations and same-store sales expectations. In Q3 2022, O'Reilly reported sales of $3.80 billion, which was a 9.2% year-over-year increase from $3.48 billion a year ago, and was a decent beat versus consensus analyst estimates by $84 million. Sales continue to reliably grow each year, and we project this growth to continue even in an economic slowdown. Perhaps a mild slowdown is bullish when coupled with the high rates for financing, as it keeps cars on the road longer.

So what is driving these sales? Let us turn to comparable sales. Comparable sales are a critical indicator for a company like this. Comparable sales have been improving every year, the COVID-19 crisis notwithstanding. This is a critical metric, and we were bullish on comps. We expected at least 5-6% positive comps based on historical metrics, but O'Reilly far surpassed our expectations here. The comparable sales came in exceeding our expectations, hitting 7.6%. This was a nice rise, and coupled with 2021 and 2020 results, the three-year stacked comparable sales growth is a whopping 31.2%. This is outstanding. After these results, we are projecting for the remainder of 2022 a comp sales figure of over 5.0% for the year, and preliminarily in 2023, we see at 3.5-5.0% as likely. We think this is a bullish but realistic range and will be attained if not exceeded, barring a severe recession.

While the actual percentage increase in comparable sales cannot rise forever realistically, the trend is absolutely solid. As long as comps are positive, it is a good thing. We love that management has a very measured approach to expansion as well and strategically opens new stores for added growth. They opened another net 154 shops in the last year and currently operate 5,910 stores in 47 states. The company also operates 28 stores in Mexico. Continued sales growth is bullish as the company is opening new stores strategically. Looking ahead to 2023, we expect another 175+ stores to be opened as well.

Now, revenues are up, but what about earnings power? Well, this is one area where bears could latch on, as margin power was down slightly from a year ago, When COVID-19 landed, management worked hard to cut costs. Operational efficiency continues to this day. It is quite exciting, but margins did contract some. Gross margins came in at 50.9%, down from 52.3% a year ago. This is still strong and led to a 6% increase in gross profit. Operating income for the third quarter increased 7% to $804 million, or 21.2% of sales, from $755 million, or 21.7% of sales. The big gains in revenue and still strong operating margin expansion helped EPS grow. We saw EPS rise 14% to $9.17 from $8.07 per share. This result also beat consensus by $0.66. Other than some margin compression, this was an outstanding result, and the momentum should continue moving forward.

Looking ahead

We love that the company is increasing total sales and seeing positive comparable sales. The company has also done a solid job controlling expenses, but gross margins are on the decline. We would love to see margins in the mid-50% range. If O'Reilly manages to do this, earnings will not only rise even more, but the stock could rocket higher. It may be tough to do coming into a time where the company may have to get more promotional if the economy softens too much, but we think that this would only be temporary. Keep in mind, there will be new stores opening, also helping revenues.

Now, what we love about this company is that it has followed the growth path of AutoZone largely. What do we mean? Well, to push earnings per share even higher and further boost shareholder value, O'Reilly continues to have a great buyback program. O'Reilly invests a lot of excess cash into the buyback program, which we believe is one of the best approaches to building shareholder wealth. It has worked, as you can see with the trends in EPS over the last few years.

Here in Q3 2022, O'Reilly invested another $710 million into new purchases at an average price of $683.09 per share. This helped drive EPS to $9.17, which as we know crushed consensus estimates. With expectations for at least $7.00 in EPS in Q4, we see 2022 EPS approaching $32.50. As we look ahead to 2021, we could see the stock earning up to $40 per share in fiscal 2023 depending on the level of buybacks and the state of the economy, but see at least $35 in EPS next year. We see this as likely from growing comps mid-single digits, growing sales through new stores, margins over 50%, and the high level of share repurchases.

Final thoughts

This was a superb Q3 for O'Reilly Automotive, Inc. With this bump over $800, our members have about doubled their money in a stock that has held up very well in a very tough 2022. We think you back out the entire initial position plus 20% profit and let the rest run forever. New money can buy, but wait for a pullback. We remain bullish long-term on O'Reilly Automotive, Inc.

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