AutoZone: High Expectations And Inventory Build-Up Create Short-Term Worries

| About: AutoZone, Inc (AZO)


Autozone reports a solid set of third quarter results.

The market is disappointed and perhaps slightly worried about the inventory build-up.

Shares offer compelling value on significant dips.

Investors in Autozone (NYSE:AZO) took profits after the retailer and distributor of automotive replacement parts and accessories released its third quarter earnings results.

Higher inventories were a worry after the company reported its 31st consecutive quarter of double digit earnings per share growth. That being said the long-term track record makes shares appealing on dips.

Third Quarter Highlights

Autozone reported third quarter revenues of $2.34 billion which was up by 6.1% compared to last year.

Reported net earnings came in at $285.2 million which was up by 7.4% compared to the year before. Thanks to sizable share repurchases which are a tradition of the company, earnings per share were up by 16.4% to $8.46 per share.

Looking Into The Performance

Autozone's sales growth was driven by comparable store sales growth of 4.0% which in its turn was aided by the harsh weather conditions of course. Harsh weather pushed up demand for failure related products in the second quarter which deferred demand for maintenance related parts. On their turn demand for maintenance parts saw a rebound in the past quarter.

Gross margins improved by 20 basis points to 52.0% of sales. Lower inventory shrinkage, which in retailing is a combination of employee theft, shoplifting, vendor fraud and administrative errors was beneficial to Autozone's gross margins. While the company cited improvements in the inventory shrinkage, it failed to provide information about how large these improvements actually were.

This was offset by higher supply chain costs related to the boost of inventories which impacted margins by 25 basis points.

Operating expenses rose by 40 basis points to 31.5% due to higher payroll expenses as well as gains posted last year on the disposal of assets.

The one item in the earnings report which got investors worried was the 12.0% jump in inventories which is due to greater product placements as well as store openings. The inventory built-up exceeded sales growth by quite a margin, driven by the company's strategic desire to maintain more inventory to boost its service.

Having more inventory in service of various kinds increases the odds that needed spare parts are available directly on the spot, thereby pleasing customers. Yet growing inventories do eat up working capital, and increase the odds of Autozone carrying obsolete parts, notably for older cars and models.

Share Repurchases

During its third quarter, Autozone repurchased 795,000 shares at a cost of $420 million for an average price of $529 per share.

Under its current authorization the company is allowed to repurchase worth another $307 million in stock. This came after the company already spend $912 million on share repurchases this fiscal year.

The company is serious about repurchasing its own shares and not only during the good times. Over the past decade it has retired more than 60% of its shares outstanding while significantly growing revenues and earnings along the way.

Valuing Autozone

The company ended its third quarter with $145.3 million in cash and equivalents. Total debt stands at $4.38 billion which results in a sizable net debt position of little over $4.2 billion.

Sales for the first nine months of the year came in at $6.42 billion, putting the company on track to report revenues of $9.7 billion as earnings could approach $1.1 billion.

At around $520 per share, the market values the company at $17.3 billion. This values the company at 1.8 times annual revenues and 15-16 times annual earnings.

The company does not pay a dividend to investors, instead it resorts to share repurchases to ¨return¨ cash to its shareholders.

Takeaway For Investors

The company ended the quarter with 5,279 stores in total and is still a very much US based company operating 4,901 stores in the country. This came after Autozone opened 30 stores during the past quarter.

The company has a unique and strong financial business model. To provide great service, Autozone has to hold a lot of inventory in total $3.13 billion, or $594,000 per store. Yet the company pays suppliers very late with accounts payable actually exceeding its inventory position by 14%. This is remarkable as the company reports an annual inventory turnover ratio of just 1.5 times per annum which means suppliers are still happy to provide their goods to the company despite Autozone paying them very late.

It appears that despite the favorable financing terms, the market is a bit worried about the growth in inventories after the company met both earnings and revenues consensus estimates for the quarter.

For the future the company continues to focus on growth through organic sales as well as new openings. Organic sales growth is driven by the company's strong position in the ¨do-it-yourself" market, a $47 billion market in which the company is a leader. The real potential is still in the fragmented $59 billion ¨do-it-for-me¨ market. Further growth is targeted through e-commerce and foreign expansion, while the company continues to focus on opening a 150 domestic stores per annum.

On significant dips the company continues to offer compelling long-term value. I am a buyer around $450.

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.