In March, when Seth Jayson wrote aboutAutoZone (NYSE:AZO), the nation's leading retailer of auto parts and accessories, sales and profits were up and return on invested capital (ROIC) had increased from 21.4% to 24.5%. At $84 a share, the stock traded at just 13 times earnings.
AutoZone reported its latest quarter this morning. Same-store sales, the benchmark for all retailers, were up 2%. Revenues were up 6%. Earnings per share jumped 14%. And, you guessed it; the stock is up today to, drum roll please, $84 a share.
When Jeff Hwang wrote about AutoZone last September, the company was "crushing" analyst estimates and the stock was $92.65 a share. Yikes! All this good news and still the market races away from AutoZone.
What exactly is under the hood that's burning a combination of solid performance and a low price-to-earnings (P/E) ratio to produce a cheaper stock? How about debt at 7.6 times equity? When most experts would call a debt-to-equity ratio of 0.35 times prudent, AutoZone's $1.7 billion in debt is downright frightening. Or is it?
If you get a moment, check out Bill Mann's excellent discussion of return on equity (ROE). Briefly, ROE reveals how well a company is generating returns on retained shareholder equity -- that is, money it could return to you. In his piece, Bill cites retailer Abercrombie & Fitch (NYSE:ANF) with an ROE of 25%. AutoZone reported its ROE had increased from 71% last year to 131% this year.
Clearly, debt is a double-edged sword. On the one hand, if you can get high returns and business stays strong, debt can boost your ROE. The downside is that you have little room for error, and a string of bad quarters can be like cement shoes -- you don't swim far in the financial pool before you sink from sight.
To its credit, AutoZone has used debt to expand its business and buy back stock. Since 1998, cumulative share repurchases have totaled $3.4 billion, or 78.3 million shares, at an average price of $42.89 per share (vs. today's $84). And AutoZone's performance is unrivaled.
In addition to strong sales, the company's 18.5% operating margins look fantastic when compared with the 1% eked out by Pep Boys (NYSE:PBY) or the 7.4% at Genuine Parts (NYSE:GPC). Even Wal-Mart (NYSE:WMT) -- yes, the company with the tiny auto parts department -- enjoys operating margins of just 5.5%.
The debt may be an issue to some, but while the stock is down 5% for the past 52 weeks, AutoZone is hardly spinning its wheels. The smoke is rising and the tires are getting hot and ready to take hold. (Sounds like a Beach Boys song, doesn't it?) At 11 times 2005 earnings, AutoZone really may be a decent bargain.
Will W.D. join Seth and Jeff in shaking their head as Wall Street ignores AutoZone's fantastic performance? Join other investors discussing AutoZone and Pep Boys.
Fool contributor W.D. Crotty does not own stock in any of the companies mentioned.
