Investing in U.S. auto-parts retailers has been a road to riches.
Over the past five years, as the Standard & Poor's 500 has almost doubled, the four major companies in the space have seen their shares rise from 150 per cent to more than 300 per cent. Over the past two decades, AutoZone Inc. has seen its stock rise 2,700 per cent – and that's not good enough for the crown, as O'Reilly Automotive shares have risen nearly 6,700 per cent.
Each company has consistently expanded by buying smaller operators and opening new stores in new geographic markets. And they've been aided by the aging of the U.S. automobile fleet, as the financial crisis and the subsequent punk economy made many consumers decide to try and keep their old cars on the road rather than plunk down for new models. That's meant the big players have boosted profits significantly since 2008, and the stocks are trading at higher price-to-earnings multiples than they have in at least a decade, per S&P Capital IQ.
The growth opportunities in selling to car owners willing to do their own repairs – the "do-it-yourself," or DIY market – may be lessening, however. That's led all the companies to look to sales to mechanics and commercial auto repair shops – the "do-it-for-me," or DIFM, market, which is much more fragmented and presents growth opportunities via acquisition.
Servicing mechanics, who need part orders filled quickly and correctly, is a bit of a different business with greater infrastructure needs. So while the overall trends in the business remain positive for the long run, it suggests some of the companies – and their investors – might find the road ahead a bit bumpier than the one just travelled.
If you're used to the idea of heading to Canadian Tire – and nowhere else, really – for auto supplies, you might be surprised at the U.S. car-part retail sector. AutoZone, O'Reilly, Advance Auto Parts and Genuine Parts Co. (branded as NAPA) own or sell exclusively to more than 20,000 locations, nearly all from 6,000 to 8,000 square feet. (Genuine Parts is the least appealing to investors seeking a pure play; automotive parts is just 53 per cent of the company's revenues, with industrial parts, office products and electronics materials making up the rest.)
The most expensive of the bunch is O'Reilly, which closed Friday at $219.53 (U.S.), or roughly 25-times forward earnings. O'Reilly was an early adopter of the approach of selling both to the DIY and DIFM markets, historically generating a 50-50 mix, says Adam Fleck, director of consumer equity research at Morningstar. That means the company has built up the infrastructure and relationships to serve commercial customers, giving it "a considerable lead" over rivals like AutoZone and Advance Auto Parts.
In its most recent earnings, O'Reilly reported same-store sales growth – sales open at locations at least one year – of 7.2 per cent, easily outpacing rivals. The company's track record of execution means the only bad thing analysts generally have to say about the stock is its valuation. Just half of the 26 analysts covering the company currently have "buy" ratings, according to Bloomberg.
The bulls say, however, you can still get more than what you pay for. Greg Melich of Evercore ISI says O'Reilly is "the poster child of 'compounders' – i.e. stocks that may not look 'cheap' on current earnings … but can move higher thanks to execution, solid industry backdrops and loyal customers."
Analysts are most positive, interestingly, on Advance Auto Parts, the company that seems to have the most problems right now. (Fourteen of 25 have "buy" ratings.) The company is still digesting the 2014 acquisition of the parent of CarQuest (which has Canadian locations). That deal should take DIFM sales to 60 per cent of the company's revenue from just 15 per cent a decade ago. But the company's same-store sales have lagged, Mr. Fleck notes, and it seems to be less efficient than peers.
That, however, has made it the cheapest of the group on a multiple of EBITDA, or earnings before interest, taxes, depreciation and amortization. Mr. Melich, who has a "buy" rating, acknowledges "much integration heavy lifting remains," but he sees cost-cutting and revenue gains leading to increased earnings per share in 2016 and after.
Kate McShane of Citigroup Global Markets Inc. says Advance Auto Parts "has a history of underperformance," so she strongly suggests AutoZone, which has a more consistent track record and a new strategy to boost its DIFM sales, which are less than 20 per cent of its mix. Nearly 50 per cent of the company's sales come from its own higher-margin private labels, she adds. This week, she increased her target price to $800, versus Friday's close of $673.62. AutoZone's trailing position in the DIFM market is other analysts' typical concern, with just seven of 26 tagging the stock a "buy."
So, while for this country's motorists virtually all roads lead to Canadian Tire, investors have a broader set of choices: O'Reilly may offer the smoothest ride, but also the priciest trip. AutoZone and Advance Auto Parts may offer more detours along a path to larger profits. Enjoy the summer driving season.
Under the hood
Canadians used to getting car parts at Canadian Tire may not appreciate the number of large players in the fragmented U.S. auto-parts retail market. Our southern neighbours have four separate public companies comparable in size or larger than Canadian Tire, by way of revenues – and investors place higher values on all of them.