Dissecting AutoZone's Earnings Growth (The Results May Surprise You)

| About: AutoZone, Inc (AZO)

Earnings growth is one of the most important metrics for investors. It is the fuel for growth stocks and is often the single largest factor in a company's valuation. Thus, it is critical to understand what drives a company's earnings growth so that you can assess whether, and for how long, that growth can be sustained.

There are several companies that have displayed incredible earnings growth since the economy bottomed in 2009. One of those companies is AutoZone, Inc. (NYSE:AZO). AutoZone is a distributor and retailer of automotive parts and accessories. The company was founded in 1979 and now operates more that 4700 stores in the U.S. and more than 300 in Mexico.

AutoZone's shares have more than tripled in price over the past several years, and currently trade at $350. This rise in price has been driven by consistent earnings growth between 20%-30% over that period. The chart below illustrates AutoZone's earnings growth using a four-quarter rolling average to account for seasonal effects.

As the chart shows, AutoZone's earnings growth rate peaked after FY11 Q2 and has dropped slowly since that time to around 18% in the most recent quarter. Analysts project that AutoZone will earn $27.63 per share in FY13 and $31.13 in FY14, which represents 13% growth. In other words, analysts are projecting that AutoZone's growth rate will drop from 18% to 13% over the next seven quarters.

To assess whether this assumption is reasonable, investors should understand what has been the catalyst behind AutoZone's earnings growth over that time period. For Autozone, the results of this analysis may surprise you.

Dissecting AutoZone's Earnings Growth

For most companies, earnings growth typically results from revenue growth, cost reductions, and/or share repurchases. Quite often, these growth drivers vary over time. For example, a young company may generate earnings growth by rapidly increasing revenue. Then, as the company matures, it may streamline its cost structure and achieve growth through increased margins. For established companies, earnings growth may be propelled by using free cash flow to buy back shares.

Starting first with revenue, a retailer like AutoZone typically achieves growth by opening new stores. The first chart below shows the actual earnings growth rate starting in FY10 Q2 compared to the earnings growth without any new store openings. Note that only revenue was adjusted in these calculations--profit margin was held constant. As the graph shows, new stores provided about 4.5%-6.5% of earnings growth over the period.

Another way that retailers grow revenue is by continually increasing sales per store. The chart below compares the actual earnings growth to the growth that would have been achieved if sales per store were held constant at the levels achieved for the four quarters preceding FY10 Q2. According to the chart, increased sales per store provided more than 6% growth during FY11, but has since dropped to around only 2% in the two most recent quarters.

Turning next to expenses, the following chart shows the difference between actual earnings growth and the growth that would have been achieved if gross margins for the four quarters preceding FY10 Q2 were applied to all future quarters. Because AutoZone's gross margins are very stable and have not increased much, it is not surprising that gross margins have not contributed to earnings growth.

Last, but certainly not least, the following chart shows the difference between actual earnings growth and the earnings growth that would have been achieved without any share repurchases over the period. The magnitude of earnings growth realized by AutoZone through this driver is remarkable. As the chart shows, share repurchases have been the largest contributor to earnings growth and generated nearly 15% growth throughout FY11 and the first half of FY12. The impact of share repurchases in the most recent two quarters has resulted in "only" a 10% boost to earnings growth.

What to Watch For In the Near Term

To monitor AutoZone's earnings growth going forward, keep an eye on its share repurchase program. That has been, and will continue to be, the biggest earnings growth driver for the company if the past is any indication.

The next most important driver is new stores. The company has been opening around 200 new stores each year, and should be able to maintain that growth in the near term with its expansion into Mexico.

Although it has not been much of a growth driver recently, investors should also keep an eye on AutoZone's sales per store. The growth rates have dropped significantly and are now in danger of turning negative on a year/year basis.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.