Shorting AutoZone Isn't Easy, Abandoning It Is

Dec.25.11 | About: AutoZone, Inc (AZO)

Going short is not for the weak of heart. The old adage that the “market can remain irrational longer than you can remain solvent” isn’t something to be brushed off the shoulder like an old wive's tale might. This is so, especially in an age of digital sheep, where investors (both institutional and retail) follow programs, algorithms, and various trading patterns instead of a fairer sense of intrinsic company values. But like in all good things, true fairness tends to ultimately have its day in the sun in a free market economy.

The leveraged rise of AutoZone, Inc’s (NYSE:AZO) share price is an instance where questioning the trend has been a difficult journey to take. If you were short this company for the past year alone, a higher share price of over 30% wouldn’t have been incurred without much pain. Yet it doesn’t take a genius to note that a company that is taking on debt to buy back stock at ever higher prices, while degrading the intrinsic value of the company isn’t setting itself up for the greatest business model.

In a time where ponzi schemes have been introduced as a common household term, one does question how it is that companies can blur the lines with similar, yet entirely legal practices.

AutoZone Inc. (AZO) 2011 2010 2009
Total Liabilities $7.12 Billion $6.31 Billion $5.75 Billion
Total Shareholder Equity ($1.25 Billion) ($739 Milion) ($433 Million)
Net Tangible Assets ($1.56 Billion) ($1.04 Billion) ($735 Million)
Click to enlarge

Debt continues to rise, shares continue to be bought, insiders continue to sell.

The one factor that keeps the story going, however, might be found in the rising operating cash flows. As the auto part revival story is reliant on a population which is going through more hoops to extend the lives of their cars, AutoZone’s expansion remains plausible and justified. We see therefore, that as long as management continues to expand the amount of stores, rely on added-back depreciation, and hope the economy doesn’t improve anytime soon, it’s long on its merry way to wrecking its balance sheet in order to support higher share price buybacks.

Investors who look at charts and see nothing but upside for AutoZone might one day inherit the weakness being built into the company. AutoZone now trades at a $13 Billion market capitalization, despite having a negative value of $1.34 Billion of shareholder equity. Likewise, the company sports a hefty price tag of $330 per share despite having a negative book value of -$34.26.

For more rational investors looking to find a greater intrinsic value in the same industry, O’Reilly AutoParts (NASDAQ:ORLY) is just a stone’s skip around the corner. There, one would at least find a management board that is looking to build up the company’s balance sheet by increasing the value of shareholder equity rather than leveraging it unnecessarily.

Pep Boys – Manny, Moe & Jack (NYSE:PBY) is another viable alternative. Improving cash flows, a balance sheet that works, and a sustainable growth has kept this company running since 1921.

Advance Auto Parts Inc. (NYSE:AAP), however, has been struggling from an operational stand point and might be no better off at improving its intrinsic value than AutoZone has been. Nevertheless revenues have been consistent and growing providing hope for a better tomorrow.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.