Autozone Offers Attractive Long Term Risk/Reward With Short Term Government Stimulus Benefit

Summary

• Autozone (AZO) is currently trading at a price that offers investors an opportunity to acquire an outstanding company at a reasonable price.
• Firm has done exceptionally well during COVID-19 with a long history of high cash flows, ROIC and excellent shareholder returns.
• Firm is well positioned to continue to benefit from government stimulus packages based on direct correlation with stimulus and revenues in 2020.

The below is not intended to provide a comprehensive analysis of a firms operating characteristics, industry, financial performance or valuation assessment.  We believe the best investment ideas are simple and easy to understand and can be distilled into a short summary covering the key factors and potential catalysts.  Each investor should undertake their own due diligence and assessment based on individual considerations. 

AZO was not immune to the COVID-19 related downturn in early 2020, however owing to its counter-cyclical industry (used car parts retailer), revenue declines were limited to 1% in the May-20 quarter.  Subsequently, strong demand from DIY (retail) customers, a growing DIFM (commercial) business and government stimulus drove outstanding same store sales growth through 2020 and provides a favorable tailwind into 2021.

In our view, current prices offers investors a compelling opportunity to acquire shares in an outstanding business at attractive prices.  This is underpinned by several key factors summarised below.

Background

• AZO operates a simple business model (largest US auto parts retailer) in a fragmented yet consolidating industry that favors scale operators;
• The business (and industry) is counter-cyclical, delivering stongest performances coming out of recessionary periods without corresponding decline in business (i.e., customers obtained typically remain customers);
• AZO has delivered strong operating stability, with 15 year average GPM of 51.6% (lowest any year of 49.4%) and EBIT margin of 18% (lowest: 17%)
• Mgt has delivered outstanding long term shareholder returns (1170%  or 17.9% p.a.) since Aug-05, underpinned by a combination of revenue growth (5% p.a.) and margin expansion (net income growth: 8% p.a.) while reducing outstanding shares by ~70% (8% p.a.);
• A negative cash conversion cycle, coupled with moderate use of debt has supported steady store growth without substantial capital investments, supporting shareholder returns;
• Since the May-20 quarter (revenue declined 1%), AZO has delivered outstanding growth, both absolute (FQE Aug-20: 14%, Nov-20: 12.7%, Feb-21: 15.8%), underpinned by same store sales growth (22%, 12.3%, 15.2%).  Strong growth reflected both DIY (retail) and DIFM (commercial) customers driven in part by government stimulus (retail) and expanding its commercial business; and
• Initially suspending the buyback program in 2020 to preserve liquidity ($1.7Bn at Nov-20), mgt spent $900M in the most recent quarter (3% of current market cap) on buybacks while maintaining $1.0Bn in cash.

Opportunity

Based on the current price, AZO sells at a 15.7x LTM P/E multiple and a 12.1x FCF multiple (LTM Aug-20), attractive multiples given long term history and positive outlook for continued steady market consolidation, growing commercial market share and strong cash generation.

Further, this is supported by the following:

• New US government stimulus packages should directly benefit auto parts retailers supporting continued growth in the upcoming quarter, whilethe opening of the US post vaccine will lead to higher miles driven (key driver of auto parts demand);
• While comps may be challenging given outsized growth in 2020, we expect AZO will retain a portion of its customers and continue to benefit from industry consolidatio and its commercial growth strategy;
• Relatively stable operating margins (notwithstanding some pressures business mix) given operating scale and business model coupled with top line growth should continue to support steading net income growth; and
• An ongoing favorable shareholder return policy.  With an estimated $800M in suplus cash on balance sheet plus $1.75Bn+ in annual free cash flow generation (average of last 3 years), management have the capacity to repurchase ~9% of total shares outstanding over the next 12 months (based on a stable share price).