AutoZone Continues To Impress

About: AutoZone, Inc. (AZO)
by: Leo Nelissen

AutoZone once again beat EPS expectations after a very successful business quarter.

The stock has reached a new all-time high thanks to rising margins, a solid store expansion, and a rapidly declining number of shares outstanding.

One of the headwinds continues to be weaker economic growth which means I will wait before I buy this stock again.

AutoZone (AZO) has been the go-to stock for traders who are looking for retail exposure. The auto parts retailer just published its second quarter earnings of its 2019 fiscal year which showed once again the company's ability to grow in a tough retail environment. Going forward, we will see if slowing consumer sentiment can stop this trend. Other than that, I think the stock is a good place to be.

Source: AutoZone

Record Breaking

It's a while back since I wrote my last article covering AutoZone. In September of 2018, I discussed the company's rising margins as a good sign that bottom line growth would continue to get a boost from a solid retail industry.

I expect the stock to continue its rally to at least $800 on the mid-term. If economic growth stays at above-average levels, I expect the stock to hit its all-time high over the next few months. That said, the downside is a slowing economy and weaker consumer. However, at this point, there is not enough evidence to suggest that the US consumer is weakening.

Adjusted EPS soared a stunning 36% from $8.47 in Q2 of 2018 to currently $11.49. Expectations were at $10.34 which means the company has beaten expectations for the fourth consecutive time.

Sales growth was built on another quarter with solid growth. Sales added 1.6% to $2.45 billion which is slightly below expectations of $2.46 billion. One year ago, the company generated sales worth $2.41 billion with a growth rate of 5%.

The second quarter also saw comparable store sales of 2.6%. Average company-wide store sales improved from $380,000 to $386,000 over the past 12 months. Average sales per square foot rose $1 to $58. Moreover, total auto parts sales accelerated 3.1% to $2.4 billion while domestic commercial sales accelerated by 12.9%.

The bigger picture shows why the stock is such a generator of capital gains. Total sales, gross margins, and EBITDA margins all reached new highs on a trailing twelve months basis. Gross margins are just 30 basis points shy of hitting 54% while sales do not show signs of weakness yet. I could make a case of peaking sales, but I would have to try really hard to spot any weakness on the long-term chart.

It is also interesting to mention that the company did not close any stores in its second quarter. AutoZone added 20 stores in the US, one store in Mexico and two in Brazil. This brings the total store count to 5,651 in the US. Mexico has 568 stores while Brazil has 22 stores.

Macro Is Weakening

One reason why I want to discuss the macro picture is because macro has been one of the two reasons why the stock is at a new all-time high. Economic growth did really well in 2018 and the company did its own job by raising margins which led to a strong bottom line outperformance.

Both industrial production and retail sales of motor vehicles and parts have done tremendously over the past few years. The post-2016 economic recovery almost pushed both indicators to 10% year-on-year growth. Q4 2018 growth of auto parts retail sales was at 1.50% while industrial production growth was at 1.60%.

Unfortunately, the growth rate of retail sales in January was at just 0.20% which means that the trend is continuing. Both industrial production and retail sales growth rates are weakening like we saw in 2015/2016 when growth dropped towards 0%.

Back then, we got a much needed boost from a synchronized rally backed by strong commodity prices, rapidly rising wages, and overall rising consumer sentiment. All things considered, we are still at a point where economic growth is supportive of strong earnings. The problem is that we are in a slowing cycle which started at the end of 2018 as I discussed in this article.

This brings me to consumer sentiment, which has rolled over. 4 of the past 5 months had negative growth with February growth coming in below -5%.

Source: University of Michigan

One thing is for sure: the easy times are gone. Retail is getting harder with consumer sentiment starting to decline.

AutoZone is a very hard nut to crack for short sellers and pessimists. One reason in addition to rising margins and strong comparable store sales is the fact that the company continues to invest in buybacks. The number of diluted shares outstanding has declined to 26.4 million shares. At the start of 2016, this number was still above 30 million. It's truly impressive to see a decline this significant without any pause.

Another thing that is impressive is the fact that even after this rally, the company still has a forward PE Ratio of 14.4 with a PE ratio of 17.7. This is not at all overpriced or the result of irrational buying.

That said, the new all-time high is completely deserved. The company continues to grow its margins while the store expansion is continuing without any major interruptions.

Source: FINVIZ

The only thing that bugs me is the turning economic cycle. What good is a cheap valuation if the underlying economy is slowly declining? That's why I have sold almost every consumer-related stock in my portfolio. However, I am not advising anyone to short anything. I don't even think it's a good idea for long-term investors to sell AutoZone. The only thing I think is very important to mention is that mid-term traders might get a better entry as the stock rally has resulted in a somewhat weak risk/return at this point. I think both traders and investors should wait for the next correction to start a position or to add to an existing investment.

Other than that, I continue to be impressed with this retail beauty.

I'll keep you updated!

Thank you for reading my article. Please let me know what you think of my thesis. Your input is highly appreciated!

Disclaimer: This article serves the sole purpose of adding value to the research process. Always take care of your own risk management and asset allocation.

Disclosure: I/we 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.