Should You Buy This Aftermarket Retailer?

Stiff competition and lackluster sales at existing stores make AutoZone unattractive.

Jan 8, 2014 at 3:47PM

The auto-parts industry has had a nice time as the winter sets in, as customers bring in their cars for repair more frequently when the weather gets cold. This has meant more revenue for auto-parts retailers such as AutoZone (NYSE:AZO), which posted a great quarter last month. AutoZone's numbers also came in ahead of the Street's expectations, sending the stock higher.

Yet another successful quarter
The auto-parts retailer has been enjoying revenue growth as the average age of vehicles has increased over the last few years, and the previous quarter was no exception. AutoZone's revenue jumped 5.1% to $2.09 billion as demand for repairs increased. The increase in repairs not only occurred because of a cooler autumn but also because warm weather last year resulted in fewer repairs, pushing demand into the current period. Moreover, storms in the U.S. played an important role in boosting the top line.

AutoZone expanded its footprint by adding nine new stores, which added to its revenue.. Moreover, AutoZone has been expanding in the Brazilian region, which has high demand for auto parts.

The auto-parts retailer also managed its costs well, as reflected by an increase of 7.2% in net income over last year. In fact, earnings per share increased by 16% as earnings clocked in at $6.29 per share as a result of a lower share count. In fact, AutoZone's gross margin also expanded slightly to 51.9% from 51.8%, last year.

Stiff competition
Although AutoZone has been a great performer, there are some other points to consider. For example, AutoZone's growth has mainly been driven by its additions of new stores, since its same-store sales grew at a meager 0.9% pace. On the other hand, peer O'Reilly Automotive (NASDAQ:ORLY) has been able to grow its same-store sales by 4.6% in its latest quarter. In fact, O'Reilly expects comparable-store sales growth of 3%-5% in its fourth quarter as the retailer gears up its promotional activities. Also, the retailer's loyalty program has been instrumental in attracting customer attention.

Moreover, O'Reilly Automotive draws 40% of its revenue from the commercial-repair business, which has been doing well. Even AutoZone's revenue from commercial repairs surged 14% over last year. However, the commercial segment provides only 16% of AutoZone's revenue. Therefore, O'Reilly should benefit from the growing segment much more than its peer.

Additionally, Advance Auto Parts (NYSE:AAP) is about to acquire General Parts International this year, which will strengthen its commercial-repair business, making the company the largest auto-parts retailer with annual revenue of more than $9 billion. Also, the acquisition will help the acquirer reduce annual expenses by $160 million. Hence, the acquisition will lead to higher margins as well as an improved bottom line for Advance Auto Parts.

In fact, Advance Auto Parts has been making a number of moves to strengthen its commercial-business segment. The company acquired 124 BWP stores in order to expand its presence in the segment.  Therefore, AutoZone will face tough competition from this retailer as the prospects of the commercial-repair business brighten.

Measures to overcome competition
Because of competitive pressures, AutoZone also plans to expand its commercial business. The retailer added 100 new commercial programs in order to strengthen its commercial-business segment.

Also, the company has undertaken new inventory initiatives and upgraded its technology, which should lead to better operational efficiency. AutoZone also deployed a customer-loyalty program that offers discounts to customers on the basis of their past purchases. This should attract more customers, leading to higher sales.

One of the key drivers for any auto-parts retailer is the decrease in gas prices. Lower gas prices lead to an increase in usage of automobiles, which results in more wear and tear of vehicles. Moreover, William C. Rhodes, CEO of AutoZone, expects gas prices to fall in the winter months, which should increase the company's sales.

Final words
Although AutoZone has been trying to boost its performance by various means, it has been unable to combat competition. Additionally, Advance Auto Parts' acquisition will make AutoZone lose its market position. Moreover, AutoZone's same-store sales growth is a matter of concern. If AutoZone continues to open new stores without seeing much growth at existing stores, the auto-parts retailer will face difficulties. Hence, expanding the commercial business, outpacing competitors, and increasing sales at existing stores are the needs of the hour for AutoZone. Until then it will be better to stay on the sidelines and wait for the right time to enter.

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Pratik Thacker has no position in any stocks mentioned. The Motley Fool owns shares of O'Reilly Automotive. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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