AZO - There's More To Find Under The Hood At AutoZone

2023-06-28 12:42:49 ET

Summary

• While investors may be spooked by AutoZone's relatively high price per share, the company is not wildly overvalued against historic averages.
• AutoZone is the leader of retail do-it-yourself car repair, and has a fast-growing commercial segment as well.
• Over the past decade, AutoZone has delivered a total return of 493%, significantly outperforming the broader S&P 500's return of 225%.

Background

While it is difficult to assert objectively that some businesses are better than others, there are just some businesses and business models out there that are... well... just difficult to make work. Airlines, famously, belong to this category: capital intensive, heavy regulatory burdens, and susceptible to the whipsaws of the public's ability or willingness to purchase the goods sold.

Other businesses, however, decidedly do not belong in this category. Their business is regular and does not require high outlays of capital, are somewhat predictable, and the goods provided are ones which consumers typically need versus want. The subject of our article today - AutoZone ( AZO ) - falls firmly into the latter category. Founded in 1979, the company currently operates 6,248 locations across the United States and today has a brand that has become somewhat synonymous with do-it-yourself auto repair.

A quick glance at AutoZone's chart reveals that, over the long haul, business has been good to the auto parts retailer.

On a total return basis over the past ten years, AutoZone has appreciated by 493% as of this writing, compared with the broader S&P 500's ( SPY ) return of 225%.

In this article, we'll consider whether the company's longer-term uptrend is sustainable, or whether it may be time move on. Let's dive in.

Valuation

We won't spend much time here, but we would be remiss if we didn't at least set a valuation baseline for the stock. For a company that has experienced so much upward price momentum, one would expect that earnings-based valuations have been stretched. Interestingly, while forward valuations have been stretched a bit, that assumption does not appear to fully bear out in reality. This means that the company has more or less proportionally increased its profitability as the price of its stock has also increased.

Over the past ten years, AutoZone has had an average forward P/E of 16.3x. Today, the stock trades just above that at 17.6 times earnings. On a forward EV/EBITDA basis, the company currently trades at 13.1x against the ten-year historic average of 11.4x. Not too bad.

Overall, we believe that AutoZone seems to be just a tad expensive at current levels against historic earnings-based valuations. This is what we would expect to see if the company's outlook and prospects were not materially different than they were in the past. AutoZone, however, has an interesting and relatively fast-growing business segment which we think deserves investor attention.

Commercial Opportunities

AutoZone ended its May 2023 quarter with sales of $4 billion. What dominated headlines at the time, however, were the company's anemic same store sales, which came in at only 1.9% growth year over year and which executives blamed on a wetter-than-normal March which kept consumers indoors and away from retail centers more than normal.

The company's brick-and-mortar and online retail business - which most readers are familiar with - is only part of the story, however. AutoZone also has a fast-growing commercial business, where the company partners to supply local repair shops, garages, and service stations with commercial credit and parts in part by utilizing existing brick-and-mortar spaces. This segment has been in operation for some time, but the growth has been strong and steady. In 2011 AutoZone's commercial operation hit $1 billion in yearly sales . As of today, the operation accounts for almost 30% of overall revenue at $1.1 billion in the May quarter alone.

This is important - it can be argued that AutoZone's retail operations have reached something close to maximum penetration in the domestic U.S. market. Without a catalyst to drive top-line revenue growth, it's hard to see how AutoZone stock continues to move upward or how valuations could reasonably re-rate.

Management, for their part, believe that the commercial operation has a long runway ahead. In this vein, CFO Jamere Jackson noted in the most recent conference call that "our commercial business should grow double digits as far as the eye can see, and we maintain that conviction despite this quarter's results. We are significantly underpenetrated with a four to five share in an addressable market that is approaching $100 billion."

Leadership Transition

On June 26th, AutoZone announced its plans for CEO Bill Rhodes to resign and assume the mantle of Executive Chairman of the Board. Periods of leadership transitions are always fraught for investors - if the CEO is well-regarded by shareholders and has a clear strategic vision for the company, who's to say that a new CEO will continue on the same path?

We think, however, that incoming CEO Philip Daniele, is a choice that investors will feel comfortable with. First, the company has announced the transition well in advance (it doesn't take effect until January 2024), and Daniele is a 29-year AutoZone veteran who currently oversees the company's Merchandising, Marketing, and Supply Chain operations. While every CEO charts their own path once they take the helm, it is reassuring to know that the company did not go with an outside hire for the role - especially with the former CEO staying on as Chairman.

The Bottom Line

With an incoming CEO who is intimately familiar with the business, a growth-driving commercial segment, and relatively in-line valuation against historic norms, we think that AutoZone represents an interesting situation for investors to consider. Of course, nothing is guaranteed: even internally-sourced CEO transitions can go poorly (Disney ( DIS ), anyone?), and macro-headwinds could have a strong effect on the commercial business, but at today's price and valuation we think the benefits are likely to outweigh the risks for certain investors.

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