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One quarter later and I'm still perplexed by Wall Street's enthusiastic response to AutoZone's (AZO) results, which have pushed the stock to trade at or near new highs.

Don't get me wrong: I understand intellectually why the stock has been bid up: It's an Eddie Lampert name. Big earnings per share growth because of stock buybacks. Gross margins nice and fat thanks to cost cutting.

But drill down and it's the same old story: Virtually no sales growth. Ditto for same-store sales, which lag competitors. Sales per square foot down for nearly a dozen consecutive quarters. Inventory turns low. Owned inventories up.

The company itself says that "sales improvements have been slower to materialize" than previously expected.

And remember the much ballyhooed pay-on-scan inventory method, would get suppliers to hold merchandise on their books until it was sold at retail? Wasn't all inventory eventually supposed to be pay-on-scan? Doesn't appear it's heading in that direction and management now refers to it merely as "one of the tools" it uses in its quest to have a 100% accounts payable to inventory ratio. (Huh?)

All of which begs the question: Should this really trade at a multiple similar to competitors that have faster sales growth? Wall Street obviously doesn't think so. I know, I know: It's all about the cash flow. But the cash flow wouldn't have been what it was if the earnings weren't what they were, which they wouldn't have been if it hadn't been for an eye on costs.

But as is always the case with earnings-from-cost-cutting stories, you can only cut costs so much. Sooner or later operations and sales growth matters, financially engineered earnings, be damned.

AZO 1-yr chart:

azo

See also: Updated: AutoZone - Time for a Reality Check, AutoZone F1Q07 (Qtr End 11/18/06) Earnings Call Transcript

Source: AutoZone: Sooner Or Later, Sales Growth Matters