O'Reilly Automotive Benefits from the Slump

I am beginning a starter position in O'Reilly Automotive (ORLY); this is a name we've been stalking for a while [Jan 15, 2009: Thesis - Automotive Replacement and Accessories] but I never pulled the trigger. The stock was actually down Monday on an analyst downgrade while much of the more speculative junk was up 20-30%.

• Despite a market rally Monday, shares of auto parts retailers fell on worries that the stocks may have peaked and that the companies may face less ideal economic conditions down the road. Auto parts retailers have gotten a boost over the past few quarters as more consumers opted to invest in their current vehicles while delaying purchases of new ones.
• Brian Nagel of UBS Investment Research said that the aftermarket companies have not only benefited from the drop in new vehicle sales, but also lower gas prices and weak consumer confidence.
• "In our view, however, shares now largely reflect the benefits of a more accommodating environment and are susceptible to an unfavorable multiple resetting should the rate of improvement in trends slow and / or the focus of investors shift further to stocks more leveraged to economic recovery," Nagel wrote in a note to investors.
• The analyst cut his ratings for both AutoZone (AZO) and O'Reilly to "Neutral" from "Buy." He reiterated his "Neutral" rating for Advance Auto Parts (AAP).
• Nagel noted that gas prices are already up about 20 percent from their December lows and said he expects new car sales to improve toward the end of this year.

Unlike the Kool Aid we hear everywhere each time the market rallies, in my opinion we are going through a sea change for the consumer and this is not your daddy's recession. Car sales cannot keep falling 40%+ year over year, but new car sales will be weak for a long time since people don't have house ATMs to fund their car purchases.

That said, in the SHORT term all that matters is perception in the stock market, and the more people who think the economy is ready to rebound "in 6 months" (based on paper creation at the Federal Reserve) the weaker this type of sector will be. So this is not a "fast money" trade. If this rally continues, I'd expect the leadership stocks of the last month or so (like ORLY) to struggle as people run into speculative junk because "the consumer is back!"... but when the market invariably reverses, the junk will once again implode and I'd expect former leaders to regain the mantle....

I am starting with a 1.7% stake in the $33.50s but I am cognizant of a nasty gap down near $28 which could be filled. If we get down there I will be loading up... but if we begin to break down below $32 I'll first cut back what I bought today and wait for $28 to refill the position in larger scope. We punted a lot of long positions whose charts had weakened the past few weeks, so I'm looking for new replacements. This is one.

[Mar 3, 2009: Autozone (AZO) Surges 10% on Weakening Consumers Sticking to Fixing What they Have]

Disclosure: Long O'Reilly Automotive in fund; no personal position

Comments

[Ranjit Thomas]

ORLY hasn't generated any cash in the last 3 years, with free cash flow being more than negative $40Mn in 2008. It spends a huge amount on capex, and doesn't seem to flow it through into depreciation, thus inflating earnings. Aggressive accounting at best, borderline fraud at worst. Why would anyone want to buy a company at 18x low quality earnings, when half the market is trading at a single digit multiple?

2009 Mar 25 09:11 AM