When discussing auto stocks to put money into, investors probably immediately think about the incumbents in the industry, like Ford or General Motors. There are also electric vehicle makers like Tesla and luxury car stocks like Ferrari. These companies might have their own investment merits worth considering.
But if I could buy only one auto stock, it wouldn't be an original equipment manufacturer (OEM). It would be after-parts retailer O'Reilly Automotive (ORLY -0.97%), without question. Here's why.
Strong financials
The most obvious reason to like this business is its outstanding financial performance. Between 2017 and 2022, O'Reilly's annual revenue increased at a compound annual rate of 10%. Same-store sales growth has also been superb, averaging close to 8% in those five years.
This is an extremely profitable enterprise. In the first quarter of 2023, O'Reilly posted a gross margin of 51% and an operating margin of 19.3%, with both figures holding steady over the past several years. Management expects operating margin of roughly 20% this year.
Perhaps the most attractive characteristic of O'Reilly is its ability to generate ridiculous amounts of free cash flow (FCF). This is a firmly profitable company consistently. And capital expenditures, which go toward building new stores, are easily covered by operating cash flow. So, O'Reilly produces a ton of FCF, to the tune of $2.4 billion in 2022 and an estimated $1.8 billion to $2.1 billion in 2023.
Management has used this FCF to buy back stock. In the last 10 years, the outstanding share count has shrunk by 45%. This benefits existing stockholders by boosting earnings per share.
Scale advantages
The automotive aftermarket industry is highly fragmented. Many smaller, independent shops out there also serve the same customers as O'Reilly. However, it's almost impossible for these subscale rivals to compete with O'Reilly, which will continue stealing market share over time.
That's because, in this industry, the availability of parts is everything. If a person's car isn't working, that's a huge problem. They need to get back on the road as quickly as possible, to run errands or get to work.
With its huge physical footprint of 5,971 stores and 28 distribution centers (as of Dec. 31, 2022), O'Reilly undoubtedly has a wider selection of inventory than its smaller competitors. Moreover, the company's sheer scale allows it to negotiate more favorable terms with its suppliers.
Durable demand
Whereas traditional car manufacturers are very cyclical, seeing revenue decline during economic downturns, O'Reilly has proven to be resilient to recessions. It was able to grow annual sales throughout the Great Recession. Even during the pandemic, supply chain issues, and now an uncertain economic environment, the business is exhibiting strong momentum.
It's not difficult to understand why O'Reilly has this favorable attribute of durable demand. When the economy is expanding and times are good, consumer confidence is high, and people usually drive more. This increases the wear and tear on their vehicles, resulting in the need for the products O'Reilly sells.
Even in recessions, when consumer confidence is low and unemployment is higher, people will hold off on buying that new car. They'd much rather direct their limited discretionary spending power toward trying to extend the life of their current vehicle. Again, this supports the demand for O'Reilly.
Zooming out, there are longer-term trends benefiting the company. The average age of cars on the road in the U.S. goes up steadily each year, and the miles driven rise as well.
All of this is to say that O'Reilly is a wonderful business to own. Its current price-to-earnings ratio of 27 might be above its trailing five-year average, but the stock should be on your radar.
