O'Reilly Automotive (NASDAQ:ORLY) plunged 8% when it announced its Q3 results last week. However, the stock retrieved almost half of its losses on the next day. Therefore, it is only natural to wonder whether the plunge of the stock is justified or it has presented a great entry point. In order to answer this question, one has to realize why the stock plunged and whether this cause is a game changer for the stock, which has been in an uptrend since its IPO in 1993.
First of all, there is no apparent single factor to justify the dramatic reaction of the market to the earnings report. Nevertheless, the market was certainly surprised negatively by the fact that the company missed the analysts' EPS estimates, even by a mere $0.02 (less than 1%). As O'Reilly had beaten the analysts' estimates for more than 10 consecutive quarters, with the exception of the last quarter, it was only natural for the market to be negatively surprised by the EPS miss. After all, it had got used to an average EPS beat of $0.10 in the past 10 quarters. Moreover, the company had exceeded the expected revenue in the past 10 quarters as well, by an average $40 M, while its revenue came in line with the consensus in this quarter. Therefore, the market correctly expected the company to exceed the consensus for one more time.
Moreover, the company reported 5% earnings growth and 10% EPS growth, which are much lower than its historical growth rates. To be sure, the company has grown its EPS by at least 15% for 31 consecutive quarters. However, investors should realize that the reported low figures have resulted from an extra item. More specifically, last year's earnings included a special tax benefit of $0.11 per share. If that extra benefit is left aside, then the Q3 EPS grew 15% over last year. Therefore, the seemingly disappointing growth rate resulted from a special factor and hence the shareholders should not worry about it.
Another potential cause of the plunge of the stock was the announcement of the acquisition of Bond Auto Parts, a privately held supplier of automotive parts. However, the acquired company operates only 48 stores and hence it is too small to have a meaningful effect on the results of O'Reilly. To be sure, the latter opened 52 new stores during Q3 and is on track to achieve its target of 210 net new stores this year. Moreover, it is comforting to know that the management of O'Reilly is prudent in its growth execution, which is confirmed by its growth outlook for next year. More specifically, the company has lowered its target for new stores next year to just 190 in order to execute properly the conversion of the 48 Bond stores.
From all the above, it becomes evident that the main reason for the slump of the stock after its earnings release was the fact that the market had become used to witnessing EPS and revenue beats whereas the company slightly missed the EPS estimates and its revenue was in line with the consensus. In addition, the deceleration in the EPS growth resulted from a special factor and hence investors should not worry about that.
Therefore, as O'Reilly has grown its EPS by at least 15% for 31 consecutive quarters and is still expected to maintain its exceptional streak next year, it seems that the market's reaction was mostly emotional and thus investors should take advantage of the opportunity that showed up. The stock is currently trading at a forward P/E=21.4, which is not extremely cheap but is a great entry point for a stock with such an excellent, consistent growth record. To be sure, if the stock keeps growing its EPS by 15% per year, its P/E will drop to 18.6 next year, which is a better valuation than that of the broad market, particularly given that S&P (NYSEARCA:SPY) has been experiencing flat to declining EPS in the last 6 quarters.
It is also worth noting that the macroeconomic environment continues to be favorable for the business of O'Reilly. More specifically, the price of gasoline remains around multi-year lows and is not expected to rally much higher from its current levels. Consequently, consumers continue to enjoy an essential tax cut. Thus the driven miles in the US keep climbing and have increased 3.1% in the first 8 months of this year over last year. These favorable conditions are likely to remain in place for the foreseeable future and hence O'Reilly is likely to keep enjoying these tailwinds.
To sum up, the slump of the stock after its earnings release seems to be much more emotional than reasonable. The company slightly missed the EPS estimates and caused panic to the market due to its exceptional beat record. However, the company seems poised to keep growing its EPS by at least 15% for the next few years. As soon as the dust from the sell-off settles, the market will focus on this exceptional growth trajectory and will thus reward the stock. Therefore, the stock is likely to fill the gap from the earnings release up to $277 sooner than later and will thus offer a 6% return in the short term. Moreover, as it is poised to keep posting record earnings, it is likely to soon revisit its recent all-time highs of $290, which will represent a 10% profit from the current level.
Disclosure: I am/we are long ORLY.
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.