What Drove AutoZone's Earnings Into the Ditch Last Quarter?

In this segment from Market Foolery, host Chris Hill and Bill Barker from Motley Fool Funds consider what went wrong for auto parts retailer and DIY haven AutoZone (AZO -0.02%), which turned in a pretty hefty earnings miss for the quarter. Revenue was up 1% year over year to $2.62 billion, and diluted earnings per share rose 6.2% to $11.44. But analysts' consensus estimates were for $2.71 billion in revenue and earnings of $12 per share. Beyond scoring a lower share of tax refund money, what else caused this broad miss?

Chris Hill: AutoZone's third quarter was a miss, a pretty big miss. Their same-store sales were down, the stock is down 9% this morning. That seems like a lot. How big was this miss?

Bill Barker: They missed on a lot of different areas, and I think it was the breadth of the troubles that they're looking at. The story going into this quarter was that tax refunds had been delayed, which was true, and they expected to have a pretty good end of the quarter, because once the tax refunds went out, they had a business which historically has benefited to the day, as soon as people start doing their tax refunds, their customer base is known to use that money at AutoZone.

Hill: So, there's a track record to this?

Barker: Long-term track record.

Hill: When I first heard this morning on CNBC, my gut reaction was, this kind of sounds like blaming the weather.

Barker: Oh, the weather was there, too. We'll get to that. You can overdo it on scoffing at blaming the weather as well, but we'll get to that in a second. What happened is kind, the first five weeks were slow because of that in part. Then, the last seven weeks were a little bit better, but not as much better as they needed to be, and as the company expected to be, those being the 12 weeks of the fiscal quarter. That drove, in large part, the sales miss. This is a company which I listen to the conference call when I was driving to the office today, and they repeatedly brought up that they had had 41 or 44 consecutive quarters of 10% earnings-per-share growth, which is a remarkable record. But it's over, and it's been over for more than one quarter now. So, taking the victory lap for something which has not been the case for a full half year now is problematic. The weather was an issue the last two years. This quarter, AutoZone and the other competitors in the space benefit a lot from bad weather, and the damage that does to cars and roads, which in turn damages the cars. And the unfortunate thing for AutoZone is that roads are not that damaged.

Hill: I have to be honest, I had never thought about that before. If you're AutoZone or O'Reilly, you're absolutely rooting, in some small, quiet way, for bad roads.

Barker: Financially, you are rooting for the small slip. You're not rooting for car accidents, but you know, somebody hits a little patch of ice and bumps into something, a certain amount for that happens --

Hill: Potholes.

Barker: Potholes, and the potholes are left at the end after the ice all goes out. That's a secondary benefit to sales. Well, the last couple years have been historically warm weather, and I don't have all the science behind me to tell you whether or not that's going to continue. Weather changes a lot, but the trend of the last couple decades has not been good for cold winter weather in parts of this country. And that is, maybe it's just a one or two-year thing, maybe it's a trend.

Hill: Let's go back to the IRS and the delayed checks, because as you said, that's a real thing. And let's not single out AutoZone, they're not the only retail company out there talking about the delay of tax refunds. But, it does seem, however, like their guidance is slightly off, because in theory, if there's a delay, then if their customers hold the form, then they're still going to go out and buy stuff at AutoZone, it's just not going to be within this fiscal quarter. So, in theory, again, if their guidance is correct, if their own forecasting is correct, then they should feel pretty good about the current quarter.

Barker: It would have occurred by now. All the tax refunds are back. Management points out that that surge in sales just didn't materialize, wherever those tax refunds went they were spent elsewhere rather than the percentage of them that typically AutoZone expects to see showing up in their stores. A few additional things, they have been building out some distribution centers. They've been increasing their supply of parts from once or twice a week to two or three times a week to a lot of the stores, and the traffic has not been there to justify that. So, they've taken on a lot of expense to increase their supply chain and the sales that they expected to generate from having more inventory on hand in stores is not appearing. So, they're left with a lot of expense and not enough revenue to cover it. So, not that they're not making profit, they were still profitable, their total profits for the quarter over last year's were up about 1%. AutoZone being AutoZone, they bought back a lot of shares, so their earnings per share were up 6%. But that's not the 10% to low teens that they've come to give investors expectations for.

Hill: Last question and then we'll move on, with the drop today, shares of AutoZone down around 24% year to date, when you look at that, you think, this is a value play right here. Or, given that they were off on their guidance, given the trend in weather and whether or not it holds for the next couple of decades, where do you see the stock right now?

Barker: Long-term, I think this has been a very well managed company. We've owned it, we do own it in the Great American Fund. However, the combination of macro issues, we haven't even gotten into the increased competition that Amazon is now providing for auto parts suppliers, and we haven't gotten to the long-term situation for auto parts if fully electrical and autonomous vehicles appear, as we've talked about on the show, which decreases the number of parts in a car from the thousands to less than 20.

Hill: Right. Tony Seba was our guest on Motley Fool Money last weekend, and that was one of the things he talked about.

Barker: Should everybody listen to that?

Hill: It's a pretty compelling interview, and I say compelling because I've gotten emails from listeners reacting in both directions. Some people are saying, "That was fantastic, that's really opened my eyes to a whole new possibility in terms of investing," and people are also taking the other side and saying, "Tony Seba is being incredibly assumptive about human behavior and the role of things like the oil industry and that kind of thing, and he's being incredibly aggressive with his timeline."

Barker: Yeah, it is an aggressive timeline. But whether you adopt his time line or not, if ultimately, the number of parts in a car goes from the thousands to the dozens, that's not good for AutoZone.