AutoZone: Buy For Inflation Protection And Get Recession Protection For Free

Apr. 25, 2022 12:48 PM ETAutoZone, Inc. (AZO)1 Comment3 Likes

Summary

  • AutoZone's financial metrics are excellent.
  • The company has huge gross margins giving pricing flexibility other companies don't have during inflationary periods.
  • AutoZone is only marginally affected by the chip shortage.
  • The stock is also a good choice if a recession is coming.
  • Looking for more investing ideas like this one? Get them exclusively at Turnaround Stock Advisory. Learn More »

AutoZone store

Sundry Photography/iStock Editorial via Getty Images

AutoZone (NYSE:AZO) is one of the largest automotive aftermarket retailers in the world with more than 6,100 locations in the United States, Mexico, Puerto Rico, Brazil, and the US Virgin Islands. Other well-known competitors include O'Reilly (ORLY) and NAPA.

Auto parts stores in the US

scrapehero.com

AZO locations are very well distributed across the USA as seen in the following graphic. Texas (641), California (634), and Florida (381) are the states with the most locations. And as the following map shows, the US east of the Mississippi is very well covered.

AutoZone location map

AutoZone

For example, there are six AutoZone stores within 10 miles of my suburban Chicago home.

AutoZone has many advantages when it comes to dealing with an inflationary environment and in this article, I will explain why AZO should be considered an investment option if you are concerned about future inflation.

And, oh, by the way, they do pretty well during recessions too if you are like me and concerned about that issue.

AutoZone's financial metrics are excellent

If we look at AZO's key financial metrics over the last 10 years we can see large, continuous improvement. All numbers from Seeking Alpha's financial library.

AZO metrics

Seeking Alpha and author

On a revenue increase over the last 10 years of 81%, AZO has increased its share price by 472% and its EPS by 375%. EBITDA and FCF (Free Cash Flow) have also increased by triple digits.

The share price has continued to be boosted over the years by share buybacks every single year for the last 10, reducing the share count from 42 million to 28 million. And there is still a $2 billion buyback to go.

So just based on the financial metrics alone you could make a strong argument for buying AutoZone shares.

AutoZone has huge gross margins giving them pricing flexibility other companies don't have during inflationary periods

AZO's gross margin is huge at 52% meaning on average they buy things for 48 cents and sell them for a dollar. This gives AZO flexibility in times of stress that most companies do not have.

How does that margin compare to other companies? Here is a comparison between AZO and two of the companies, Ford (F) and General Motors (GM), whose products they often compete with.

Gross profit margin for AZO and peers

Seeking Alpha

So AZO works with a 50% plus gross margin while Ford and GM work with less than 15% margin. This is why auto companies and many others with lower margins have less flexibility in dealing with inflationary pressure.

AZO is a member of the S&P 500 and if we look at share pricing for the last year (inflation at 8.5%) we can see that AZO with a 46% increase in share price has done much better than the S&P 500 (SPY) with an 8% increase.

AZO price return

Seeking Alpha

Of course, there are other factors than margins involved, but the corollary between inflation and price is evident in those two graphs above.

The other positives for AZO and inflation are twofold.

First, parts inflate too and with huge margins, this is beneficial for AZO. In fact, 2022 motor vehicle parts are headed for the 3rd largest inflationary gain in history at 9.38%

Price inflation for motor vehicle parts and equipment since 1977

2013dollars.com

The second advantage is that AZO can choose to buy parts from companies that are sourcing from low-inflation countries like Vietnam, China, Taiwan, or Mexico.

Here's an example of MOOG products sold by AZO that are actually the same part sourced from two different countries. Obviously, a lower purchase price combined with a higher sales price leads to even higher margins than normal.

Part comparison

suspension.com

In this particular example, China's current inflation rate is 1.5% versus Germany's 7.3% so AZO would buy this part from China. With current parts inflation at 9.38% (see above chart) buying parts from a country whose inflation rate is only 1.5% would increase AZO's margins.

AutoZone is only marginally affected by the chip shortage

While the automotive industry, in general, is affected by not only the shortage of chips but also by the increasing number of chips required for manufacturing new cars.

Auto parts companies like AZO, on the other hand, are typically dealing in less sophisticated parts like brakes, mufflers, spark plugs, and anti-freeze. Also, because of the less complex nature of their products they often have many sources to choose from for any particular product.

In fact, AutoZone benefits from both chip shortages and high inflation because both cause prices for new automobiles to increase. When those prices increase, people are less likely to buy new cars and are more likely to keep their current cars which by definition will require more parts replacement than new cars.

The same could be said for used car buyers because used car prices have been going up rapidly too, increasing by an average of 37% in 2021. This has led many people to just keep their current car until used car prices come down as evidenced by a decrease in used car unit sales reported by CarMax (KMX) last week.

That means those not buying cars will require more spare parts than new or newer used cars do thereby benefitting AZO.

AutoZone is also a good choice if a recession is coming

Goldman Sachs says there is a 35% possibility of a recession hitting the US within the next two years.

And when recessions do hit the result is lower inflation rates which can be easily seen in the following graph:

Consumer prices rise by most since 1981

Yahoo

Note in every case since at least 1970 when recessions hit inflation (via the CPI) diminishes rapidly.

Well, the last recession (not including COVID-19) was from December 2007 to June 2009. As can be easily seen, AutoZone more than held its own during that difficult economic period when compared to both the S&P 500 (SPY) and the NASDAQ index (QQQ).

AZO price return

Seeking Alpha

Conclusion: AutoZone is a good choice no matter what is coming down the road

We know that inflation is already here and there is also much talk about a recession hitting sometime in the not too distant future. Inflation causes doubt in everyone's mind and consumers are left dealing with ever-increasing costs for virtually everything they buy.

Where inflation is and isnt

Yahoo

You will notice that five out of the top nine items with the highest inflation rates are related to autos. That's AutoZone country.

So AutoZone is well-positioned to not only weather inflation's rapid rise, but could also see its margins increase as it purchases parts from countries with lower inflation rates.

In addition to inflation protection, AutoZone also has shown good performance during the recession of 2007 - 2009 giving you an excellent investment option for whatever may be coming in the future.

As with most other public companies, a resurgence of COVID-19 like pandemic could affect travel thus lessening the need for auto parts in general. Also, one long-term threat is EVs (Electric Vehicles) since they are constructed with fewer parts than gasoline-powered cars.

AutoZone is a Buy for those concerned about inflation and/or recession.

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This article was written by

Bill Zettler profile picture
12.65K Followers
Focused on value stocks with turnaround potential and low risk/reward ratio
Trained as a scientific programmer, I worked on war game software for NORAD (North American Air Defense) and statistical software for Abbott Labs. For most of my 40-year career developed and sold financial and accounting software. Was principal or founder of 3 small (5-30 employees) software companies. Wrote a book on public pensions and a play that won an award in Writer Digest Magazine's annual writers competition, a contest that draws over 10,000 entries a year. Currently retired.
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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.

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