AutoZone Investment Thesis
I last covered AutoZone (NYSE:AZO), a best-in-breed auto parts retailer, in May of 2021, and since then the stock has performed even better than I predicted, up over 35%. This is not without warrant, as the company handily beat both revenue and EPS expectations in the following quarters. Additionally, expansion into Latin America, growth in DIFM, and further development of mega hubs, will enable accelerated top-line growth. AutoZone's free cash flows also remain strong, supporting an aggressive buyback program. Accordingly, I have raised my price-target on the stock to $2,600/share.
What's happened since May
I published my last article on AutoZone on May 17, 2021, and in the following three reported quarters the company has performed admirably. Continuing an impressive string of beats, AZO beat on the top-line by ~20% each quarter, and revenues by ~8% each quarter.
According to Seeking Alpha, this resulted in 16 upward EPS revisions by analysts and 0 downward, which bodes well for the future.
Free cash flows have also continued to grow, up to $3bn in the TTM, up 3.71% over the prior year (keep in mind that AZO has only reported Q1 thus far).
Company growth initiatives
In quarterly conference calls, management at AutoZone has repeatedly laid out two primary growth initiatives: expansion into Latin America, growth in do-it-for-me (DIFM), and the growth of so-called mega hubs.
Expansion into Latin America
The chief driver of growth for AutoZone in Brazil and Mexico will be an increase in store count. The market in these two countries is far from saturated, and some simple math can help reveal what AZO's footprint can eventually look like there. Per my estimates, the number of AutoZone stores in the USA is about 1 per 55,000 people. In Brazil and Mexico, it's closer to one in 480,000. Even accounting for the lower number of the cars per person in these two nations versus the USA, you still reach a potential market size of about 2,000 stores. At $1.85mn in average revenue per AutoZone store, Latin America could eventually contribute $3.7bn to AZO's top-line.
DIFM
While AutoZone is known for being the go-to place for do-it-yourself (DIY) repairs, they have become a force to be reckoned with in the DIFM space as well. For those wondering, the difference between DIY and DIFM is that DIY is individual consumers, while DIFM is geared towards repair shops.
In the most recent quarter, AutoZone reported that DIFM grew 29.4% on a YoY basis, and a whopping 41% on a two-year stack basis to $900mn, or 25% of total sales. This is incredible growth and is powered by what management calls a "highly fragmented portion of the market." AutoZone is consolidating this space and I fully expect growth to continue in this segment.
Mega hubs
AutoZone separates their stores into three groups: satellite stores, hubs, and mega hubs. Traditionally, AutoZone focused on satellite stores (they carry ~20,000 SKUs). They are now emphasizing hubs and mega hubs as they are more efficient and drive higher sales, offering a wider selection (4x more than satellite stores). CFO Jamere Jackson said it best on the Q1 2022 conference call:
As a reminder, our mega hubs typically carry roughly 100,000 SKUs and drive tremendous sales lift inside the store box as well as serve as a fulfillment source for other stores. The expansion of coverage and parts availability continues to deliver a meaningful sales lift to both our commercial and DIY businesses. And we're testing greater density of mega hubs to drive even stronger sales results.
AutoZone currently has 62 mega hubs, with plans to increase that number to 88 by the end of their fiscal year (AZO's fiscal year ends August 28th). I expect this will help drive AutoZone's revenue growth above their historical range of 2-5% top-line growth and analyst expectations.
Share buyback program is still going strong
As I highlighted in my last article on AZO, AutoZone's share repurchase program has enormously boosted shareholder value. This strategy has continued, with AutoZone announcing two $1.5bn increases to the share repurchase authorization (equivalent to 6.9% of shares), bringing the total amount authorized for repurchase since going public to $29.2bn.
I anticipate this buyback program to continue at a >$3bn annual pace, as management has given no indication of slowing down, and incremental leverage can be taken on as well to further boost buybacks beyond just the free cash flow that is generated.
Source: Author's own work with some data sourced from Tradingview
Valuation
I'll look at AutoZone's valuation three ways: relative, on a DCF basis, and on a reverse DCF basis.
Relative
On a relative basis, AutoZone appears modestly undervalued, at 15.8x EV/FCF, compared to the upper-teen numbers for their closest peers apart from Advance Auto Parts (AAP).
Comparing price and growth via the price to earnings growth (PEG) ratio also makes AutoZone look attractive at 0.587x; this is lower than all peers except for Advanced Auto Part.
Discounted Cash Flow Model
In my model, I assume annual free cash flow growth in the 6% range, driven by the aforementioned factors. Discounting these cash flows back at AZO's weighted average cost of capital (5.33%), I find that the present value of their future free cash flows through 2026 is $14.28 billion. I chose a terminal multiple of 15x 2026 FCF and add that to the sum of the cash flows. After subtracting net long-term debt, I reach an intrinsic value of $54bn, or ~$2,600/share. This is 24% above the current share price.
Reverse DCF
Using the same discount rate and terminal multiple assumptions in the DCF, it appears as though the market is pricing in -0.5% growth over the next five years from TTM free cash flow of $3.0bn.
I highly doubt that AutoZone will not grow earnings at all for the next 5 years, and this suggests that there could be upside in the coming months.
Source: Author's own work with some data sourced from Macrotrends
Risks
The main risk facing AutoZone, electrification, hasn't evolved much since my last article. The coming of simple, electric, cars is still a question mark for AutoZone, as EVs have a fraction of the moving parts of an ICE vehicle. However, I believe that EVs will not have a meaningful impact on AutoZone for the next decade at the earliest, as they still do not have mass adoption.
Takeaway
In summary, AutoZone is a best-in-breed auto parts supplier with significant tailwinds at its back, which should bolster its revenue growth above the historical range and beat analyst expectations. Despite the massive runup these shares have seen over the past twelve months, I wouldn't be afraid to take a starter position in this compounder.
Wilcox Research
Contrarian investor covering deep value equities. I conduct due diligence on individual names with a focus on inflection points and catalysts. Actionable ideas only.
Analyst’s Disclosure: I/we have a beneficial long position in the shares of AZO either through stock ownership, options, or other derivatives. 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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