Markets & Finance

AutoZone: Shifting to High Gear


By Efraim Levy, CFA AutoZone (AZO), the largest U.S. retailer of automotive parts and supplies, is poised to accelerate. It should benefit from the opening of additional new stores and higher sales at existing outlets, led by the expansion and rollout of the commercial customer business. The shares carry Standard & Poor's highest investment ranking of 5 STARS (buy).

AutoZone sells car parts and accessories through more than 3,100 AutoZone stores throughout most of the U.S. and in 41 in Mexico. Its strategy is to offer everyday low prices, and it attempts to be the price leader in hard parts -- crucial components such as alternators and batteries. Its commercial-sales program delivers parts to professional repair shops.

We at S&P expect AutoZone sales to grow at a percentage rate in the mid- to upper-single digits for the next several years, driven primarily by revenue increases at existing stores and by new store openings. We foresee low- to mid-single-digit same-store sales increases to be stimulated mainly by additional commercial sales and new-product offerings and by an expanding do-it-yourself segment. An increased proportion of lower-margin commercial sales will likely restrict gross margins, but the overall product mix should improve through better marketing.

RISING EPS. AutoZone should benefit from the rising number of aging vehicles in their prime repair years and by increased vehicle usage. We expect the number of light trucks (SUVs, pickups, and minivans) that are more than seven years old -- the point after which vehicles tend to require more post-warranty repairs -- to steadily increase during the next several years. Parts and accessories for light trucks have higher average retail prices -- and therefore higher margins -- than those for cars.

Helped by expectations for new-store openings, higher comparable stores sales, improved operating margins -- as well as fewer shares outstanding as a result of stock buybacks -- earnings per share in fiscal 2003 (ending August) should rise to $5.12 from $4.00 in fiscal 2002. We see an additional 13% increase in fiscal 2004, to $5.80. AutoZone's premium valuation to some of its peers, based on its price-to-earnings, price-to-free cash flow, and price-to-sales ratios, is warranted given its better net margins.

The recent authorization of an additional $500 million for share buybacks should be accretive to EPS. AutoZone has repurchased $2.4 billion of its common stock since fiscal 1998.

NOT RISKLESS. Based on Standard & Poor's Core Earnings methodology, we estimate earnings of $5.03 a share in fiscal 2003, reflecting modest levels of options expenses and minimal pension expenses. With that figure only 1.8% lower than our $5.12 estimate for operating earnings, we view the earnings quality as high.

While we find AutoZone's valuation to be compelling, risks also lurk. The company could fail to achieve higher comparable-store sales or to successfully open new stores according to plan. Also, an unfavorable shift in its product mix could occur as lower-margin items account for a greater percentage of sales. And geopolitical events could disrupt demand.

With our expectations of mid-teens average annual EPS growth for the next three to five years, we believe the shares have the capability to trade at 15 times forward earnings (still at the low end of historical range), which implies a $77 price target -- around 19% above AutoZone's current price. Analyst Levy follows U.S. automobile stocks for Standard & Poor's


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