O'Reilly Auto Parts'
Same-store sales growth for the quarter was very strong coming, at 9.2%, helping O'Reilly achieve a 33% increase in adjusted earnings per share. I am still most impressed with the growth of the company's adjusted operating margins, which were 13.6% in 2010 compared with the 11.1% generated in 2009 soon after its massive $1 billion acquisition of West Coast auto parts leader CSK Auto.
O'Reilly's conversion of more than 1,000 CSK stores, including 884 just in 2010, has been very impressive and a significant part of the company's growth. But the higher-margin retail growth has proved much more elusive from the acquisition than continuing its leadership in the commercial business. For the full year, O'Reilly is guiding operating margins between 13.9% and 14.4%. However, as the company struggles to grow its retail business, especially through its newly acquired stores, higher margins will become more difficult to attain.
The commercial leader
Before recommending that investors step to the sidelines toward the end of last year, I was very bullish on the auto parts sector -- and O'Reilly in particular. O'Reilly is the industry leader in the commercial do-it-for-me market, generating 50% of its revenue by selling parts to independent garages that fix-up a growing fleet of aging cars. The industry as a whole has benefited greatly from the recession as new car sales drove off a cliff, and the fleet of cars on the road continued an almost two-decade-long increase in average age. However, O'Reilly benefited even more than its largest competitors, Advance Auto Parts
The three retailers combined only account for slightly more than 13% of the total $40 billion dollar commercial aftermarket business, so there is plenty of room to grow. As O'Reilly's competitors try to add more of this revenue to their mix, O'Reilly is trying to win more retail business in order to not be too reliant on its lower-margin commercial business, especially in its new CSK stores. However, its competitors are having much more success moving in the opposite direction as O'Reilly.
Slower growth in retail
For example, Advance reported last week that in its fiscal fourth quarter it achieved double-digit commercial same-store sales growth for the 12th consecutive quarter. During that time, its commercial sales grew 57%, increasing from only 27% of total revenue to 34%. AutoZone has seen 14 straight quarters of sequential commercial sales growth, improving its share of the business from 11.6% in 2009 to 12.4% today.
O'Reilly hasn't seen similar improvement with regard to its retail business, and management sounded somewhat unsure of how it would generate continued retail sales growth at its acquired CSK stores. According to CEO Gregory Henslee, "There's a lot of DIY (do-it-yourself) business being done on the West Coast and we feel like that we're not getting the share that we should have."
Additionally, the bulk of its retail business seems to be promotionally driven, meaning the majority of sales are generated from the extremely low-margin chemical and oil business. These are typically loss leaders for the parts retailers because consumers could just as easily walk into their local Safeway or CVS to buy a few quarts of motor oil. Even megaretailers like Wal-Mart
O'Reilly is still the best operator in the commercial space by a wide margin and will continue to be a safe bet because of this steady business. However, I want to see management more confident in its ability to grow the retail side of its business before I can recommend the stock again. O'Reilly is not faltering by any means, but in order to meet its margin targets over the next year, I believe it will need both of its revenue streams to show strong growth this year.