AutoZone: Time To Buy?

| About: AutoZone, Inc (AZO)
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Summary

Vehicle sales have grown strongly over the last seven years.

Sales to owners of cars of seven-years and older are a key part of the company's business.

We expect this to be the start of a boom for AutoZone and believe the company will deliver solid bottom line growth over the next few years.

With its shares down significantly since the turn of the year, now could be an opportune time to invest.

Vehicle sales in the United States once again went through the roof last year. Although February's data has shown a slight slowdown, we feel that 2017 is still on track to be a successful year for vehicle manufacturers. With bucket loads of cars on the road we expect this to result in consumers buying more products from automotive retailers such as AutoZone (NYSE:AZO). Its share price has thoroughly underperformed the market this year and dropped lower, is this a buying opportunity?

AutoZone is the nation's leading automotive replacement component distributor and retailer. Although the company has posted an 11% increase in earnings per share for the first-half of FY 2017, it has still seen in its share price fall 8.5 year-to-date, compared to a 5.5% gain from the S&P 500 (NYSEARCA:SPY). The reason for the decline so far this year in our opinion is a combination of Amazon (NASDAQ:AMZN) announcing plans to expand its presence in auto parts retailing and a significant top and bottom line miss in the second quarter. While we can't argue against the weaker-than-expected second-quarter, we can against the concerns over Amazon. We agree with the view of BTIG and believe AutoZone is less threatened by e-commerce than its peers.

As you can see above, U.S. vehicle sales have increased at a solid rate since 2010 after the post-GFC crash. In 2015 and 2016 total vehicle sales across the country reached 17.5 million and 17.55 million vehicles respectively, bringing sales back up to pre-GFC sales numbers once again. Although in February and March auto vehicle sales have slowed down a touch and missed expectations, we feel that 2017 has shown a lot of promise and expect to see sales hit at least 16.6 million for the whole year.

A favorite amongst consumers has been the pickup truck, overtaking previous favorites to become the most popular vehicle type. In fact, in January the three top-selling vehicles were all trucks. This is music to the ears of car manufacturers as this particular type of vehicle often provides higher margins.

New vehicles sold throughout 2015 and 2016 are likely to have dealer warranties and servicing for at least a couple of years, so how will this boom be good for AutoZone? Well in the immediate future it won't, as a good portion of its revenue comes from sales of oil, filters, and other necessary components typically intended for vehicles seven years or older, according to its latest 10K. Where we expect AutoZone to benefit is from the vehicles at the beginning of the boom in 2010. These vehicles are generally no longer under the original manufacturers' warranties and will require more maintenance and repair work than newer vehicles. A key advantage AutoZone has is that it has a seven-year preparation time and an immense amount of data available to it in regard to new vehicles and trends. The rise in new vehicle sales from 2010 through to 2016, and potentially 2017, gives us the confidence to believe that AutoZone is on the verge of seeing sales growth accelerate.

Currently in the third quarter, AutoZone has predicted the average age of vehicles will continue to increase, but at a decelerated rate, primarily driven by the improvement in new car sales in recent years. However, in the near term, it is expected that the number of aging vehicles will continue to increase as consumers keep their cars longer in an effort to save money. As the number of seven-year-old or older vehicles on the road increases, we expect AutoZone to see an increase in demand for the products it sells. A further boost could come from AutoZone increasing its investment in new locations. According to its latest earnings call, the business has successfully opened 37 new stores across the United States so far this year. Pleasingly, as well sales growth, we also expect investments the company has made in supply chain, infrastructure, enhancements to existing locations, and investments in technology to result in margin improvement.

A further boost could come from AutoZone increasing its investment in new locations. According to its latest earnings call, the business has successfully opened 37 new stores across the United States so far this year. Pleasingly, as well as sales growth, we also expect investments the company has made in supply chain, infrastructure, enhancements to existing locations, and investments in technology to result in margin improvement.

For the full-year analysts have predicted a 3.9% increase in sales for AutoZone, boosting its annual result from $10.64 billion in 2016 to $11.06 billion in 2017. On the bottom line the market consensus is for earnings per share growth of 11% to $45.37. It's a similar story in FY 2018, with analysts predicting sales of $11.54 billion and earnings per share of $50.27. While we wouldn't necessarily disagree with the market's view on FY 2017, we think that the company will outperform the analyst consensus estimates in FY 2018 as the first cars from the auto vehicle sales boom start to hit the seven-year's old mark. For this reason we expect earnings growth to accelerate to 13%, meaning earnings per share of $51.25 next year.

Although AutoZone has a tendency to trade at a lower multiple to its rivals, as you can see on the chart above, the gap has widened in the last 12 months. We think this has left the shares undervalued, potentially making it an opportune time to invest. Based on our earnings forecast and a price-to-earnings ratio of 17, we have a 12-month price target of $871.25. This equates to a potential return of over 24 % and a key reason we believe AutoZone is a strong buy today.

Disclosure: I am/we are long AZO.

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.