Auto-parts retailer AutoZone (NYSE: AZO ) isn't growing very rapidly, but it generates plenty of cash, and the stock isn't that expensive, even with the recent run-up. Does that make it an appealing investment?
First off, AutoZone reported first-quarter results earlier today. Our Fool by Numbers report will walk you through the details, but let's still examine some of the highlights. For the quarter, total sales grew 4.1% versus the same quarter a year ago; the figure was ahead of last quarter on a sequential basis and only a smidgen below the full-year number for 2006. Same-store sales grew only 0.3%, compared with 0.8% in last year's quarter. Overall, sales trends remain unexciting, but the company has been able to post solid bottom-line trends.
For the quarter, net income grew 8.3%, but share repurchases drove total diluted earnings growth of 16.9%. It would be great if AutoZone could keep earnings growth in the double digits, but over the past three years, it has only grown the bottom line 3.2% on average each year. The five-year earnings picture is better, as net income has advanced 26.5% and operating cash flow has grown 12.4% each year on average, but sales have expanded only 4.3% over this time frame.
The AutoZone name is well respected among the value crowd and is an Inside Value recommendation, thanks to its consistent and visible free cash flow generation. Its $243 in sales per square foot is the highest in the industry, as is its return on invested capital, which consistently exceeds 20%. The company controls in excess of 10% of the do-it-yourself (DIY) market and just a couple of percentage points of the do-it-for-me (DIFM) segment. Both collectively represent $100 billion in annual revenue, with DIY just more than half of the total, but DIFM should grow faster as autos become more technologically advanced, requiring knowledgeable technicians to diagnose microchip and other malfunctions with sophisticated, computerized equipment.
My concern with AutoZone, however, has been how long it will be able to turn in average sales growth but achieve above-average earnings and cash-flow expansion. I'm also a little uneasy about the overall appeal of the automotive-services industry. It is extremely competitive, with peers including Advance Auto Parts (NYSE: AAP ) , Pep Boys (NYSE: PBY ) , and O'Reilly Automotive (Nasdaq: ORLY ) . Even big-box behemoths Wal-Mart (NYSE: WMT ) and Target (NYSE: TGT ) carry auto supplies, even if they do focus on the higher-volume items. The industry is also growing slowly, and as autos become more complicated, they will increasingly require that specialized outside help.
My last bone to pick is that AutoZone's debt-to-capital ratio is nearly 80%. Sure, the company generates steady cash flow and is easily able to service its debt load, but the auto industry is highly cyclical and isn't currently in the best of shape, even with the economy humming along. Any major fiasco is unlikely, but a high debt load is a sure way to exacerbate any difficulties should they come along.
Sum it all up, and I find that the investment drawbacks for AutoZone outweigh the merits. The stock valuation is reasonable, and the company may just be the best pick in the space, but the industry is mature, and AutoZone is geared toward the least appealing portion of the market. Future growth will therefore be that much more challenging.
Fool contributor Ryan Fuhrmann has no financial interest in any company mentioned. Feel free to email him with feedback or to discuss any companies mentioned further. The Fool has an ironclad disclosure policy.