Published on June 18th, 2018 by Aristofanis Papadatos
Auto parts retailers have outperformed the market in the last decade, by a wide margin. To be sure, during this period, AutoZone (AZO), O’Reilly Automotive (ORLY), Advance Auto Parts (AAP) and Genuine Parts Company (GPC) have rallied 418%, 1009%, 221% and 136%, respectively, whereas S&P has advanced 119%. 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.
Three 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, the large auto parts retailers have eventually begun to feel some resistance in their growth trajectory. The main reason for the somewhat increased competition is the fact that Amazon (AMZN) entered the market more aggressively last year, when it struck new deals with some auto parts manufacturers. While the effect of Amazon cannot be quantified yet, the traditional auto parts retailers have certainly decelerated during the last 12 months. Therefore, investors should be particularly careful in the choices they make in this sector, as this market seems to be undergoing a significant change.
In this article, we will compare the expected 5-year annual 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 5540 stores in the U.S., 536 stores in Mexico and 16 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 last year. The company has essentially quintupled its earnings-per-share in the last decade, from $10.04 in 2008 to $49.88 this year.
Τhe commercial automotive aftermarket is a $60 B 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%. Thus it 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.
Nevertheless, the stock of AutoZone has been on a roller coaster since early last year. The company failed to maintain its double-digit earnings growth streak while its same-store sales have grown at a lackluster pace since early last year. When the double-digit growth streak broke, the market punished the stock harshly, sending it from its all-time high of $815 to $500, mostly due to fears that Amazon was disrupting its business model.
However, although AutoZone has decelerated in the last one and a half year, it keeps growing at a decent pace and has thus proven the market’s concerns overblown. It has also invested significant amounts to increase the frequency of delivery of auto parts and will reap the benefits from this initiative in the future.
Moreover, AutoZone can boast of having in place 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.
On the contrary, AutoZone has repurchased its shares aggressively regardless of the prevailing economic conditions. Even in the Great Recession, when most companies stopped repurchasing their shares, AutoZone reduced its share count by 23% in just two years. Overall, the company has reduced its share count by 74% in the last 16 years.
Moreover, AutoZone currently has a relatively cheap valuation, as it is trading at a price-to-earnings ratio of 13.8, which is lower than its 10-year average price-to-earnings ratio of 14.6. As a result, if it spends all its earnings on buybacks, it can reduce its share count by about 7.6% per year. Therefore, it can continue to reduce its share count at a fast pace.
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 by 11.5% per year on average in the last three years. Therefore, the stock is likely to offer a 12.0% average annual return over the next five years thanks to 10.0% annual earnings growth and a 2.0% annualized expansion of its price-to-earnings ratio.
Auto Parts Stock #2: 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 5097 stores in 47 states.
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 expected $15.40 this year. 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 $283, thus returning more than 20% per year.
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 53% in 2016 so there is still ample room for O’Reilly to keep growing.
Source: Investor Presentation
O’Reilly has somewhat decelerated in the last two years, mostly due to the above mentioned increased competition in the auto parts market. It is remarkable that the retailer has missed the earnings estimates in 4 out of the last 7 quarters whereas it had exceeded the estimates for 10 consecutive quarters in the period before.
Nevertheless, the stock has rallied 23% since its Q1 earnings release, almost two months ago. The company increased its same-store sales by 3.4% and its pre-tax earnings by 3%. While this growth is not exciting, the retailer benefited from a 9% decrease in its share count and a drastic cut in its tax rate thanks to the recent tax reform. As a result, it grew its earnings-per-share by 28%.
On the one hand, O’Reilly has decelerated in the last two years. On the other hand, the company has markedly accelerated its share repurchases in order to support its results. More precisely, it has reduced its share count by 9% in the last 12 months. In order to reduce its share count at such an aggressive pace, O’Reilly has leveraged its balance sheet. Its debt/assets ratio has climbed from 70.6% in 2015 to 94.5% now and its book value has plunged from $1.4 B in Q1-2017 to $0.4 B now. Nevertheless, the company still has a healthy balance sheet so it has ample room to continue to boost its earnings via aggressive share repurchases.
Given all the above, it is reasonable to expect O’Reilly to grow its earnings-per-share by about 10.0% per year on average over the next five years. In addition, the stock is now trading at a price-to-earnings ratio of 18.4, which is lower than its 10-year average price-to-earnings ratio of 19.3. Therefore, if the stock reverts to its average valuation level in the next five years, it will enjoy a 1.0% annualized valuation expansion. Overall, the stock is likely to offer an 11.0% average annual return over the next five years thanks to 10.0% annual earnings-per-share growth and a 1.0% annualized valuation expansion.
Auto Parts Stock #3: 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 over 60 consecutive years, which makes it a Dividend King.
The company has an enviable growth record. To be sure, it has grown its sales in 85 years and its earnings in 74 years throughout its 90-year history. Moreover, the company does not rest on its laurels. Instead it has often pursued meaningful acquisitions in order to continue to grow. For instance, it recently acquired Alliance Automotive Group for $2 B.
Source: Investor Presentation
As this is a major European player in auto parts, tools and workshop equipment, it is likely to provide a significant boost to the results of Genuine Parts in the upcoming years.
In its latest earnings report, Genuine Parts posted 2.0% growth in its organic sales and 29.6% sales growth in auto parts thanks to the above acquisition. In addition, the company reaffirmed its guidance for earnings-per-share growth from $4.71 last year to about $5.70 this year.
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 62 consecutive years. As a result, it has the fourth-longest dividend growth streak in the U.S. stock market. Moreover, its current 3.0% 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 an inconsequential dividend (Advance Auto Parts).
Genuine Parts can reasonably be expected to grow its earnings-per-share from about $5.70 this year to approximately $7.65 in 2023. This corresponds to a 6.1% average annual earnings-per-share growth rate. Moreover, the stock is now trading at a price-to-earnings ratio of 16.5, which is only slightly lower than its 10-year average price-to-earnings ratio of 17.0. Therefore, the stock is likely to offer a 9.7% average annual return over the next five years thanks to 6.1% annual earnings-per-share growth, its 3.0% dividend and a 0.6% annualized price-to-earnings ratio expansion.
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 5044 stores and 131 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 has been posting negative same-store sales in recent years. More precisely, its same-store sales decreased 1.4% in 2016 and 2.0% in 2017 and the management has provided guidance for an approximate 1.0% decrease this year.
Another striking difference between the auto parts retailers is their operating margin. While AutoZone and O’Reilly have an operating margin of 17.2% and 19.2%, 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 two years ago, promised to close this gap as soon as it took over.
Source: Investor Presentation
However, not only has the company not closed the gap, but it has posted a decrease in its operating margin, from 8.2% in 2016 to 6.3% now. Thus it is evident that the management has failed to improve the efficiency of the supply chain.
Advance Auto Parts 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 3.0% dividend. Advance Auto Parts offers a negligible 0.2% dividend and it has not 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 failed to grow its earnings-per-share in the last four years. This means that it has failed to utilize its earnings in a productive way.
On the other hand, Advance Auto Parts has enjoyed an impressive 60% rally since last summer, including a 13% rally since it reported its Q3 results, two weeks ago. The reason behind its rally is the fact that it posted a much lower decrease in its same-store sales than the market was expecting. In addition, the company greatly benefited from the drastic reduction in its tax rate, from 35.0% last year to 24.5% in Q1, and thus posted 31% adjusted earnings-per-share growth in Q1 vs. last year.
However, this breathless rally has led the stock to trade at a price-to-earnings ratio of 19.0, which is much higher than its 10-year average price-to-earnings ratio of 16.4. Consequently, if the stock reverts to its average valuation level in the next five years, it will incur a 2.9% annualized valuation contraction. Moreover, it is evident that the market has already priced in a great improvement in the performance of the company. Consequently, the stock currently has limited upside but significant downside risk.
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 2.3% average annual return thanks to this earnings-per-share growth and its 0.2% dividend, which will be partly offset by a 2.9% annualized valuation contraction.
AutoZone and O’Reilly are likely to continue to offer the highest returns in the next five years thanks to their double-digit earnings-per-share growth. Moreover, these 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.
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 enjoyed a breathless 60% rally since last summer thanks to its better than expected results in recent quarters. As a result, its upside potential is now limited whereas its downside potential will be significant whenever the next headwind shows up.