We believe that Autozone (AZO) is an underappreciated franchise that offers a compelling risk adjusted return over the next several years.  AZO, the largest U.S. based auto parts retailer by revenue, began operations in 1979 and now operates ~6,300 stores in the U.S., 740 stores in Mexico and 100 stores in Brazil.  Higher margin private label sales now account for over 50% of total sales and includes brands like Duralast, Valucraft, SureBilt, and ProElite.  The company also sells ALLDATA brand automotive diagnostic and repair software through www.alldata.com.  COVID-19 provided a substantial revenue boost to AZO’s sales, but the company’s strong service level allowed it to retain ~85% of the customers gained during that period and the business continues to grow same store sales from its new higher base.     

 

The company has an unmatched long-term track record of shareholder value creation.  A $100 invested in AZO 30 years ago would be worth over $10,000 today vs. just over $1,800 for the S&P 500.  How has the company generated these extraordinary returns?  AZO operates in a resilient and growing industry with a business model that generates a substantial amount of FCF.  Management has utilized a simple but highly effective capital allocation strategy that focuses on aggressive return of capital to shareholders through repurchases.  From January 1998 to August 26, 2023, AZO has repurchased over 100% of the then outstanding shares (154 million shares for a cost of $33.8 bil.   In addition, management has not engaged in large and dilutive M&A and there is no dividend as the focus is on reducing the share count.  We believe the company’s strategy will continue to be successful and deliver attractive long-term returns for shareholders.  

 

We believe that barriers to entry are relatively high in the auto parts retail industry with small competitors unable to rival AZO’s inventory availability and breadth.  The company’s store network and distribution system (6.9 mil. square feet of space) enables the company to hold inventory of slow-moving parts that can be quickly delivered to nearby stores as needed while smaller competitors are unable to hold as many different parts in inventory.  

 

Revenue is generated from both do it yourself (70% of revenue) and commercial customers (30% of revenue and growing).  The company has had success penetrating the commercial channel over the last several years and this remains a growth focus for management.  Commercial sales have grown to 30% of total U.S. sales, up from 21% in 2017 and AZO now serves commercial customers from 92% of its domestic locations.  Substantial investments in inventory (mega hubs) and service (typically can deliver a part to a commercial customer in 30 minutes or less) position AZO to continue to grow its commercial sales faster than its DIY sales and gain commercial market share.  Management estimates that its current commercial market share is just ~4.5% (below ORLY and AAP at ~8%) and expects to continuing growing share with a long-term target for double-digit commercial sales growth.   

 

   

 

International remains a significant growth opportunity for AZO with Mexico and Brazil the key growth areas.  Management is targeting opening ~200 stores annually in Mexico and Brazil by 2028, in addition to ~300 annual openings in the U.S.  International same store sales have increased in the high teens to 20% range over the last few years and we believe the successful model that AZO has used in the U.S. can translate into international markets.  

 

The increasing number of vehicles on the road (increased to a record 283.4 mil. in 2023) and vehicle age (12.5 years in 2022 versus 11.5 years in 2015) will provide a long-term tailwind for auto parts retailers with a growing addressable market as auto parts failure correlated with vehicle usage and age.  Vehicle supply remains tight and elevated new/used car prices support continued aging of the U.S. fleet.  Lastly, new vehicle sales should continue to outpace used vehicle scrap rates, which should drive continued growth in the U.S. fleet.

 

 

 

AZO delivers consistent revenue growth with both new store growth and same store sales growth.  Over the long-term, we believe the business can deliver MSD to HSD revenue growth with ~3% store growth and LSD to MSD global comps (international growing faster than the U.S.).  With relatively flat margins (conservative assumption) and net debt to EBITDA in line with the company’s long-term target of ~2.5x, AZO should be able to repurchase nearly $21 bil. of its shares over the next five years and reduce the share count by ~27%.  FCF generation is robust as the business model exhibits negative working capital.  We expect a ~13% EPS and FCF per share CAGR over the next five years, which is attractive for a resilient business that has consistently grown revenue and earnings.    

 

The current valuation provides a compelling entry point for long-term focused investors.  AZO shares trade at just 17.6x P/NTM EPS, representing an 11% discount to the market and a 26% discount to ORLY.  The discount to the market and peers is not warranted, given the robust EPS compounding that we anticipate over the longer-term.  Investors can expect a return at least commensurate to the EPS CAGR over the next five years with upside potential if AZO’s P/E multiple is able to expand to in line with the S&P 500 and also close some of the valuation gap to ORLY.    

 

 

 

Former CEO and Chairman Bill Rhodes has an excellent track record of delivering exceptional shareholder returns over the last 19 years.  He recently transitioned out of the CEO role while remaining Chairman.  Philip Daniele ascended to the CEO role and has decades of experience with AZO.  We expect him to utilize the same strategy that has generated outsized returns for shareholders over the long-term.  

 

The company’s short-term compensation is based on economic profit, EBIT and ROIC with an additional individual modifier.  We believe the short-term compensation plan aligns with the interests of shareholders.  Long-term incentives are paid in stock options but don’t include specific targets.   

 

While e-commerce competition and Amazon should be monitored, the auto parts retailers have not seen a significant impact from e-commerce as there is a significant service component for DIY consumers (customers also value service more than price in most circumstances) and timeliness factor for commercial customers (they need inventory quickly to finish a repair).  Estimates suggest ecommerce penetration in auto parts is only in the HSD to LDD range, much lower than other more discretionary areas of retail.   

 

Electrification should also be monitored with fewer moving parts in EVs that need to be repaired.  Since AZO typically serves cars that are 7 years or older, it will take time for the EVs to become a large portion of the aged U.S. vehicle fleet.  In addition, why EVs may fail less frequently, the cost of repair when they do fail is likely much higher and could also drive more DIY activity as consumers seek to reduce the repair cost.