Updated on March 14th, 2019 by Aristofanis Papadatos
Auto parts retailers have outperformed the market by a wide margin in the last decade. During this period, AutoZone (AZO), O’Reilly Automotive (ORLY) and Advance Auto Parts (AAP) have rallied 464%, 841% and 254%, respectively, whereas S&P has advanced 220%.
Only Genuine Parts Company (GPC) has essentially matched the performance of the S&P, with a 214% rally in the last decade. All four stocks can be found in our Sure Analysis Research Database.
A major reason for the vast out-performance is the status of this market. As this market is highly fragmented, the four biggest players have consistently gained market share from the small players thanks to the economies of scale they enjoy, which are impossible for the small players.
The biggest retailers continue to open new stores and drive the weakest retailers out of business.
Two out of the four stocks in this article pay dividends to shareholders. You can find them in our full list of 674 dividend-paying consumer cyclical stocks.
While this secular trend has resulted in exceptional returns in the last decade, competition has heated in this business in the last two years. A major turning point was the decision of Amazon (AMZN) to enter this market more aggressively.
The online giant made trade agreements with some auto parts manufacturers in 2017 and exerted significant pressure on the auto parts retailers.
However, while competition has certainly heated, auto parts retailers have returned to their strong growth trajectory during the last 12 months.
In this article, we will compare the expected 5-year annualized returns of the four big auto parts retailers by forecasting their earnings growth, their dividends and their expected valuation expansion or contraction.
Auto Parts Stock #1: AutoZone
AutoZone is the leading retailer of auto parts and accessories in the U.S. It currently has 5651 stores in the U.S., 568 stores in Mexico and 22 stores in Brazil.
AutoZone has an exceptional growth record. To be sure, it grew its earnings-per-share at a double-digit rate for 41 consecutive quarters until early 2017. The company has essentially quintupled its earnings-per-share in the last decade, from $10.04 in 2008 to $50.43 in 2018.
The commercial automotive aftermarket is a $60 billion business on an annual basis and is highly fragmented. While AutoZone has kept growing for years, it still has a market share of just 3%. It thus has ample room for future growth.
Source: Investor Presentation
While AutoZone has benefited from the fragmentation of its commercial market, its management should be praised for executing its expansion plan in an exemplary way.
AutoZone exhibited remarkable deceleration in 2017, when its multi-year streak of double-digit growth of earnings-per-share ended. Management did not provide specific reasons for the deceleration but it was obvious that competition had intensified.
As the market feared that Amazon was disrupting the business of AutoZone, the latter plunged 40% in just seven months.
However, the company has returned to its solid growth trajectory since early last year. It is growing its earnings-per-share thanks to the opening of some new stores, low-single digit same-store sales growth, small margin expansion from economies of scale and aggressive share repurchases.
Thanks to all these growth drivers, AutoZone is poised to grow its earnings-per-share by about 21% in this fiscal year.
It is worth noting that share repurchases have been the largest growth driver in recent years. During the last five years, AutoZone has grown its earnings by 32% and its earnings-per-share by 81%. This shows that more than half of the bottom line growth has come from share buybacks.
AutoZone has one of the most efficient share buyback programs in the market. Most companies tend to repurchase their shares during boom periods but suspend their buybacks during rough times.
Consequently, they end up repurchasing their shares at relatively high stock prices and hence their buyback programs hardly enhance shareholder value.
AutoZone has repurchased its shares aggressively regardless of the prevailing economic conditions. Even in the Great Recession, when most companies suspended share repurchases, AutoZone reduced its share count by 23% in just two years. Overall, the company has reduced its share count by 75% in the last 16 years.
Moreover, AutoZone currently has a relatively cheap valuation, as it is trading at a price-to-earnings ratio of 15.3. While this is slightly higher than its 10-year average price-to-earnings ratio of 14.8, it is not expensive for a stock with such an exceptional growth record.
If the company spends all its earnings on buybacks, it can reduce its share count by about 6.5% per year. Therefore, it can continue to reduce its share count at a fast clip.
Thanks to these share repurchases, it is reasonable to expect AutoZone to grow its earnings-per-share by 10% per year over the next five years. In fact, the company has grown its earnings-per-share by 12.6% per year on average in the last five years.
Therefore, the stock is likely to offer a 9.3% average annual return over the next five years thanks to 10.0% annual earnings growth, which will be partly offset by a 0.7% annualized contraction of its price-to-earnings ratio.
It is also worth noting that AutoZone is an ideal stock for those who are afraid of an upcoming recession, after a whole decade without one, but want to remain invested in the stock market. As new car sales plunge during recessions, the average vehicle age rises and thus AutoZone benefits during such periods.
In the Great Recession, when most companies saw their earnings collapse, AutoZone grew its earnings-per-share by 18% in 2008 and another 17% in 2009. Thanks to its exemplary management, the company takes advantage of its depressed stock price during downturns and implements value-enhancing share repurchases.
Overall, AutoZone offers an attractive expected return regardless of the underlying state of the economy.
Auto Parts Stock #2: Genuine Parts
Genuine Parts is a leading distributor of automotive and industrial replacement parts. It has activity in the U.S., Mexico, Canada, Australia, the United Kingdom and other countries. Genuine Parts has increased its dividend for 63 consecutive years, which makes it a Dividend King.
You can see the entire list of Dividend Kings by following the below link:
The company has an enviable growth record. It has grown its sales in 86 years and its earnings in 75 years throughout its 91-year history. The chart below shows the impressive performance of the retailer in the last decade.
Source: Investor Presentation
Genuine Parts benefits from the high fragmentation of its markets and their secular growth. Its markets grow at a 2% average annual rate while the company has an average market share of 7.5% in these markets.
Moreover, the company does not rest on its laurels. Instead it pursues meaningful acquisitions in order to continue to grow. It acquired Alliance Automotive Group, which is a major European player in auto parts, tools and workshop equipment, for $2 billion in late 2017.
In addition, Genuine Parts has acquired several small businesses for its industrial, motion and automotive segments during the last six months. All these acquisitions will significantly enhance earnings growth going forward via increased sales and cost synergies.
Genuine Parts will also continue growing its bottom line thanks to same-store sales growth. In its latest earnings report, Genuine Parts posted 4.6% growth in its same-store sales and expanded its gross margin from 30.5% to 33.5% and its operating margin from 7.4% to 7.7%.
Thanks to all these growth drivers, we expect Genuine Parts to grow its earnings-per-share by about 6% per year over the next five years.
It is also remarkable that Genuine Parts is the only stock in this group that offers a meaningful dividend. More precisely, the stock has raised its dividend for 63 consecutive years. As a result, it has the fourth-longest dividend growth streak in the U.S. stock market.
Moreover, its current 2.9% dividend yield is a significant component of its total return whereas the other auto parts retailers either don’t pay a dividend (O’Reilly and AutoZone), or pay a negligible dividend (Advance Auto Parts).
Genuine Parts is currently trading at a price-to-earnings ratio of 18.1, which is higher than its 10-year average price-to-earnings ratio of 17.0. If the stock reverts to its average valuation level over the next five years, it will incur a 1.2% annualized drag in its returns due to the contraction of its valuation level.
Therefore, the stock is likely to offer a 7.7% average annual return over the next five years thanks to 6.0% annual earnings-per-share growth and its 2.9% dividend, which will be partly offset by a 1.2% annualized price-to-earnings ratio contraction.
Auto Parts Stock #3: O’ Reilly Automotive
O’Reilly was founded in 1957 by the O’Reilly family and is one of the largest specialty retailers of automotive aftermarket parts and accessories in the U.S., serving both the do-it-yourself and professional service provider markets.
The company has 5147 stores in 47 states. Despite its impressive growth record, O’Reilly does not pay a dividend to its shareholders.
O’Reilly has an exceptional growth record. Since its IPO in 1993, it has posted record revenues and earnings every single year. Even better, it has grown its earnings-per-share at a double-digit rate for more than a decade.
During the last decade, it has grown its earnings-per-share almost 10-fold, from $1.64 in 2008 to $16.10 in 2018. This rare performance proves the quality of its management and the strength of its business model.
In fact, its IPO is one of the most successful in history, as the stock has rallied from its IPO price of $2.19 in 1993 to $366, thus returning about 22% per year on average.
The company has greatly benefited from the high fragmentation of its market. The market share of the top 10 auto part chains has grown from 34% in 2004 to 54% in 2017 so there is still ample room for O’Reilly to keep growing.
Source: Investor Presentation
While O’Reilly has grown its earnings-per-share at a spectacular 25% average annual rate in the last decade, it is impossible to keep growing at such a fast pace. In addition, the company has decelerated in the last two years, mostly due to the above mentioned increased competition in the auto parts market.
However, O’Reilly has returned to solid growth mode in the last year. The company has exceeded the analysts’ earnings-per-share estimates in 6 out of the last 7 quarters.
Moreover, O’Reilly has strong growth prospects ahead thanks to a series of growth drivers. The company increases its store count by about 200 per year (~4%). In addition, it grows its same-store sales at a meaningful pace. For this year, management has provided guidance for 3%-5% same-store sales growth.
The retailer also enhances its earnings-per-share via meaningful share repurchases. In the last four years, the company has reduced its share count by 20% or 5% per year.
Given all the above, it is reasonable to expect O’Reilly to grow its earnings-per-share by about 9.0% per year on average over the next five years. In addition, the stock is now trading at a price-to-earnings ratio of 20.9, which is higher than its 10-year average price-to-earnings ratio of 19.3.
If the stock approaches our assumed fair earnings multiple of 19.0 in the next five years, it will incur a 1.9% annualized valuation contraction.
Overall, the stock is likely to offer a 7.1% average annual return over the next five years thanks to 9.0% annual earnings-per-share growth, which will be partly offset by a 1.9% annualized valuation contraction.
Auto Parts Stock #4: Advance Auto Parts
Advance Auto Parts is a leading automotive aftermarket parts provider that serves both do-it-yourself and professional customers. It has 4966 stores and 143 Worldpac branches in the U.S., Canada, Puerto Rico and Virgin Islands.
Advance Auto Parts has some striking differences from its above-mentioned peers. First of all, while its peers have exhibited exemplary consistency in their growth record, Advance Auto Parts has exhibited pronounced volatility in its earnings in the last decade.
Moreover, in contrast to its peers, it posted negative same-store sales in recent years. More precisely, its same-store sales decreased 1.4% in 2016 and 2.0% in 2017.
Another striking difference between the auto parts retailers is their operating margin. While AutoZone and O’Reilly have an operating margin of 16.2% and 19.0%, respectively, Advance Auto Parts has an operating margin of just 6.3%.
This vast difference shows that Advance Auto Parts operates its stores much less efficiently than its competitors. Its current management, which took over about three years ago, promised to close this gap as soon as it took over.
Source: Investor Presentation
Although management had a weak start, it has eventually managed to improve the performance of the company. In 2018, the company grew its same-store sales by 2.3%. It also grew its adjusted earnings-per-share by 33% but mostly thanks to a steep decrease in the tax rate.
Management expects the turnaround to continue this year, with 0.5%-2.0% sales growth, 1.0%-2.5% same-store sales growth and expansion of adjusted operating margin from 7.8% to 8.0%-8.4%. The company has exceeded the analysts’ earnings-per-share estimates for 6 consecutive quarters.
While Advance Auto Parts has begun to turnaround, it also has another negative feature when compared to its peers. AutoZone and O’Reilly repurchase their shares at a fast clip while Genuine Parts offers a 2.9% dividend. Advance Auto Parts offers a negligible 0.2% dividend and it has hardly repurchased any shares in the last seven years.
To cut a long story short, Advance Auto Parts essentially does not offer any distributions to its shareholders. Instead it has reinvested its earnings into its business and in acquisitions but it has exhibited a volatile and mediocre growth record, as its earnings have decreased in the last four years. This means that the company has failed to utilize its earnings in a productive way.
On the other hand, Advance Auto Parts seems to have entered a growth trajectory at last. Nevertheless, the market has been overly enthusiastic about this turnaround and has already priced a great portion of future growth in the stock.
It is remarkable that the stock has rallied 91% since late 2017, i.e., it has almost doubled in less than a year and a half. Consequently, the stock currently has limited upside but significant downside risk.
Right now, the stock is trading at a price-to-earnings ratio of 19.0, which is higher than its 10-year average of 17.1. If the stock reverts to its average valuation level over the next five years, it will incur a 2.1% annualized drag in its returns due to contraction of its valuation level.
The rich valuation of the stock also renders it highly volatile and vulnerable to any unforeseen headwind, such as disappointing guidance.
Given that Advance Auto Parts has failed to grow its earnings-per-share in the last four years but is now in recovery mode, it can be reasonably expected to grow its earnings-per-share at a 5.0% average annual rate in the next five years.
In such a case, it will offer just a 3.1% average annual return thanks to this earnings-per-share growth and its 0.2% dividend, which will be partly offset by a 2.1% annualized valuation contraction.
The stock may offer higher returns if it continues to exceed analysts’ expectations but its volatile performance record renders the stock unreliable and somewhat speculative.
AutoZone and O’Reilly are likely to continue to offer the highest risk-adjusted returns in the next five years thanks to their high earnings-per-share growth. O’Reilly currently offers a slightly lower expected return than Genuine Parts but we still prefer O’Reilly thanks to its unparalleled record, its consistency and its exemplary management.
AutoZone and O’Reilly are the two auto parts retailers that have the greatest consistency in their growth record, with enviable growth streaks. This consistency is very important, as it proves the reliability of their business models and the quality of their managements.
Furthermore, these are the only stocks in this group that have aggressively repurchased their shares for years. Whenever these stocks fall due to a temporary headwind, their buyback programs become more efficient and thus greatly enhance shareholder value.
This became evident in the Great Recession, as well as in the fierce sell-off of this group of stocks in 2017.
Genuine Parts has an exceptional dividend growth record and a decent earnings growth record, which however cannot match the exceptional earnings growth records of AutoZone and O’Reilly.
On the other hand, as Genuine Parts is the only stock in this group that offers a meaningful dividend, it is the only one that is suitable for income-oriented investors. Moreover, thanks to its low payout ratio and its decent earnings growth, it is poised to continue to grow its dividend for many more years.
Finally, Advance Auto Parts is the auto parts retailer with the most volatile performance record and the worst operating margin and same-store sales. Consequently, this stock is the least reliable in this group.
In addition, it has almost doubled since late 2017 thanks to its ongoing turnaround. As a result, its upside potential is now limited whereas its downside potential will be significant whenever the next headwind shows up.