This Aftermarket Retailer Looks Like a Solid Long-Term Pick

After performing well in a challenging environment, this aftermarket retailer can get better.

Jun 18, 2014 at 5:50PM

Aftermarket retailer AutoZone (NYSE:AZO) has done well in 2014 with a stock price gain of almost 10% so far. Although the stock has performed better than the S&P 500, it has trailed peers O'Reilly Automotive (NASDAQ:ORLY) and Advance Auto Parts (NYSE:AAP). However, AutoZone is a steady performer and is the most inexpensive of the lot from a valuation perspective, which is why investors should consider taking a closer look at it.

Strong results and smart strategies
AutoZone recently posted robust third-quarter results. The second-largest auto-parts retailer in the U.S. experienced strong demand from Mexico, Brazil, and North America. Its revenue for the third quarter rose 6.2% from last year's quarter to $2.3 billion. Similarly, its net income also increased 7.4% year-over-year to $285.2 million. 

Management is pleased with the progress the company is making and anticipates tremendous opportunity ahead. AutoZone is aggressively rolling out commercial operations in its stores and started 137 new programs last quarter. Year-to-date, it has started 311 new programs, and expects to start another 89 new programs in the current quarter. With only 76% of its stores running a commercial program at present, the company believes that it can continue growing its business at a robust pace. 

A resilient performer
AutoZone performed well during the quarter in spite of various challenges such as bad weather. Additionally, due to a tough macroeconomic environment, its customers are financially constrained, while the auto-parts retailer is also under pressure due to increased gas prices.  

In the wake of such difficulties, AutoZone performed well with a year-over-year increase in sales. The acquisition of Auto Anything provided good returns, and other business units such as AutoZone.com and ALLDATA also performed well. The company is trying to digitally integrate its business, which, according to management, will help it strengthen customer relationships and increase sales. 

The way ahead
AutoZone is focusing on its commercial business to increase its profitability. In addition, it will make use of technology to improve the customer experience and optimize its operations, which includes proper inventory management. 

The company has undertaken a strategic review of its inventory, after which it is designing, developing, and implementing tests focused on improving its local market inventory availability. AutoZone is also employing certain initiatives to improve its inventory coverage in all stores.

First, it has increased the frequency of replenishment from its distribution centers. Second, it is now offering a broader assortment of products from its hub stores. Next, it has increased its store inventory holding capacity. In addition, the company has improved the overnight delivery of its products. Lastly, AutoZone has added new items on the basis of customer demand. 

Going forward, management is optimistic regarding its prospects and is pleased with the execution of its strategies. AutoZone is seeing an increase in traffic, which includes the deferrable maintenance category that was hurt due to severe winter weather earlier this year. This indicates that AutoZone should see an uptick in demand.

A better pick than peers
AutoZone faces tough competition from its peers such as Advance Auto Parts and O'Reilly Automotive. Both of these companies reported solid growth in their recent quarters that beat the consensus estimates. However, AutoZone is a better pick than its peers from a fundamental perspective. Its trailing P/E is just 17, while O'Reilly trades at an earnings multiple of 24 and Advance Auto trades at 22 times earnings. 

In addition, AutoZone's PEG ratio of 1.19 is lower than O'Reilly's 1.37, which signifies comparative undervaluation. Although Advance Auto sports a superior PEG ratio of 0.96, investors should note that it has the worst gross margin figure of the lot.

Advance Auto has a gross margin of 48%, while O'Reilly has a better one at 51%. However, it is AutoZone which is the best of the lot with a gross margin of 52%. In addition, AutoZone has the best operating margin of the three as well at 19%, while Advance Auto and O'Reilly trail with operating margins of 10% and 17%, respectively. 

The bottom line
The fundamentals are on AutoZone's side, while the aggressive roll-out of the commercial program and inventory management will lead to solid growth in the future. So AutoZone looks like a solid pick and investors should take a closer look at it.

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Amal Singh 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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