AutoZone Is Running Out of Gas as Auto Parts Retailers Misfire

 | Jul 11, 2017 | 11:00 AM EDT
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Last week investors hit the brakes on shares of O'Reilly Automotive Inc. (ORLY) after the company missed guidance. Is AutoZone Inc. (AZO) out of gas, too? 

Last week O'Reilly Automotive reported that its second-quarter same-store sales were up 1.7%, which was significantly below management's previous guidance of a 3% to 5% increase. Investors hit the brakes on the shares. Year to date, ORLY is down nearly 38%. 

Because of the disappointment at O'Reilly, investors punished auto-parts retailers as a group. Indeed, AutoZone now is down 36% this year and Advanced Auto Parts Inc. (AAP) , the worst of the bunch, is down 40%. With a predicted glut of used cars about to hit the auto market, have these stocks been unfairly punished? 

O'Reilly is the third-largest auto parts retailer in the United States with 4,888 stores in 47 states. About 42% of its sales are to professional service providers (PSP) -- such as repair and auto body shops -- and 58% of sales are to do-it-yourselfers. 

O'Reilly management blamed a mild winter and weak consumer demand, probably because of slow income tax refunds. ORLY missed first-quarter comp estimates and now the company has missed the second quarter. Last year, ORLY reported that fourth-quarter comps rose 4.8% and year-end same-store sales increased 4.8%, so this slowdown is somewhat of a mystery. 

In late February, I told investors to get out of the zone. I was concerned AutoZone's first-quarter same-store sales increase of 1.6% was far below Wall Street estimates and below the 3.5% posted in the year-earlier quarter. Like ORLY, AZO blamed the weather and the election for the poor results. 

Both companies also cited a decline in miles driven and competition from the online retail channel for softer sales. Indeed, last year Inc. (AMZN) announced it would offer same-day delivery of auto parts in 40 cities, with prices about 23% lower than AutoZone or O'Reilly. (Amazon is part of the Trifecta Stocks portfolio.)

But these reasons seem pretty flimsy; excess store capacity may be more likely to blame. 

Consider that AutoZone ended the first quarter with 5,835 stores. It has an estimated 483 units in Mexico and is adding 40 annually. The company operates eight stores in Brazil. Advanced Auto Parts has more than 5,000 locations and Pep Boys has 800 stores. If you include the nearly 5,000 stores O'Reilly operates, it's hard to see to how these stores can grow same-store sales with 15,000 auto parts stores littering the country. The competition must be brutal. They all carry the same parts, right? If nearly all these stores can deliver parts within an hour, how much differentiation can there be? 

O'Reilly also said its DIY business was weak, which implies do-it-yourselfers simply are ordering from Amazon and waiting a few days for parts in order to save a few bucks. 

On May 23, AutoZone reported third-quarter earnings of $11.44 per share, which was $0.51 below the consensus estimate. Revenue increased 1% to $2.62 billion. Domestic same-store sales fell 0.8%.

The ongoing weakness in same-store sales means AutoZone and O'Reilly will have less operating leverage, because all those stores are carrying a lot of fixed costs. To that point, AutoZone said gross profit as a percentage of sales was 52.6%, down 21 basis points versus last year. Inventory rose 7.3% to $3.8 billion. 

During the quarter, the company spent $284 million to repurchase 396,000 shares at an average price of $716. The company has $1.05 billion remaining on its current share repurchase authorization.

Despite the dramatic selloff in the group, I would continue to avoid the auto parts retailers. Earnings estimates are still too high and the technicals don't seem very favorable. AutoZone is out of gas and there is nothing under the hood for the rest of the group, either.

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