AutoZone (NYSE:AZO) is racing towards its third-quarter earnings on May 24. But before we hit that mile marker, let's stop in the pit to assess the situation and get some key investment metrics.
AutoZone was founded in 1979, went public in 1991, and is the largest auto-parts provider, with annual sales of approximately $5.7 billion. As of February, the company had about 3,655 AutoZone stores -- all company-owned -- in the United States. It claims 88 AutoZone stores in Mexico, where it sells auto and light truck parts, chemicals and accessories, and ALLDATA brand automotive diagnostic and repair software.
Retail stocks in general tend to trade off several key metrics. First is growth, which can stem from internal sources, or organic growth, which is measured by same-store sales, new store openings, and external sources such as acquisitions. Sales growth at AutoZone has largely stemmed from internal avenues and has been less than spectacular, averaging just 5% over the last five years. Organic growth has run at about 3% annually over this time frame, occasionally slipping into negative territory. The company details that sales have grown 12% over the last 12 years, so it appears that growth is leveling off over time.
The company estimates that the Do-it-yourself (DIY) auto market is a $36 billion industry and growing 4% to 5% per year, of which it estimates related sales of $4.8 billion, or 13% market share. In addition, it also tracks the "Do-it-for-me" (DIFM), or commercial auto market, a $53 billion market in which it estimates its market share is only 1.4%, or $718 million. For the upcoming quarter, pay attention to how AutoZone is growing in the U.S., DIY, DIFM, and Mexican markets, since it lists these as growth priorities. Clearly, DIFM and Mexico have the largest potential for gaining market share.
As Philip Durell has highlighted in his Inside Value newsletter, AutoZone has the highest sales per square foot and highest profit margins in the industry, as well as compelling returns on invested capital. When AutoZone releases earnings, check to see how robust the profit margins and cash generation are. This is especially important, since the company has relatively high levels of debt and subsequent noticeable interest expense.
Indeed, as sales growth has matured, the name of the game for AutoZone has become free cash flow generation. The company has worked to repurchase shares and drive EPS by reducing share count; in fact, it's even issued debt to repurchase shares, hoping to drive shareholder returns. In addition, AutoZone is frequently mentioned in the same breath with Edward Lampert, who has made a career of focusing on cash flow enhancement initiatives to drive shareholder value. Mr. Lampert has reportedly held a significant amount of AutoZone shares since the late 1990s.
The return on capital here is impressive, having averaged approximately 24% for the last three years, even as sales and earnings growth have decelerated. Net income approximates free cash flow, so stated P/E multiples are a good proxy for free-cash flow multiples. On that note, the valuation is very reasonable, with a trailing P/E of just under 13 times and about 11 times forward earnings.
The real risk for AutoZone is that it underinvests for the future by focusing on what could be viewed as more myopic cash flow and profitability maximization. Upcoming quarterly results will shed valuable light on how well management is balancing near-term and longer-term initiatives to spur shareholder returns.
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Fool contributor Ryan Fuhrmann has no financial interest in any shares mentioned. Feel free to email him with feedback or to discuss the company further.
