AGB 2023.8 - AutoZone (AZO)
Commercial Growth + Ramp in New Store Openings
Subscribe to AGB - One analysis of a good business every five weeks.
AutoZone
AutoZone is the leading auto parts retailer in the U.S., mainly known for servicing the do-it-yourself (DIY) market. As of 2023, the company operated over 6.3k stores in the U.S., 740 stores in Mexico and 100 stores in Brazil. Almost half of AutoZone’s domestic stores are located in its top 10 states, which are Texas, California, Florida, Ohio, Illinois, North Carolina, Michigan, Pennsylvania, New York and Georgia. Compared to the other large auto parts retailers, AutoZone has more consistent coverage across regions, whereas O’Reilly Auto Parts (you can read our write-up from 2021 here) is better known in the Midwest/West and Advanced Auto Parts (AAP) is better known in the Northeast.
AutoZone stores are roughly 6.5k in square footage, with approximately 90%-95% of that dedicated to selling space. Almost half of the store is for selling hard parts, which are the parts necessary to fix or to replace car engines. These parts typically turn slower than the rest of the store, which are filled with maintenance parts and accessories. To account for the slower turns for hard parts, AutoZone leverages its hub and mega hub stores, which have 70%-85% of selling space dedicated to hard parts. Customers that want hard parts not found at a regular store, can easily get them sent over from a hub or mega hub store.
Over 85% of the U.S. population lives within 5 minutes of an AutoZone location. The company’s DIY customers make trips to the store (1) when there is some kind of failure in their vehicles (batteries, calipers, fuses, pumps, etc.), (2) to purchase maintenance products (fluids, plugs, wipers, etc.), and (3) for other discretionary purchases. For fiscal year 2022, AutoZone’s revenues were split 49% Failure, 36% Maintenance and 16% Discretionary.
AutoZone leads the DIY market with ~18% market share, followed by O’Reilly ~12% and AAP ~7%. DIY customers come to AutoZone because they can get help through a series of free services that the company offers including: (1) free diagnostic tests (check engine, anti-lock braking light readings), (2) the ability to borrow specialty tools, (3) testing of batteries and other components, and (4) the collection used engine oil. Customers also have access to AutoZone’s Z-net, which they can use to look up the required parts for their jobs. DIY customers are typically in their 30s and 40s and have a car older than 11-12 years old.
While AutoZone is known for its leading position with DIY customers, the company got serious about the commercial business in 2008 and has materially grown its commercial capabilities over the past decade. AutoZone has added 150-250 commercial programs annually since 2016 and has over 5.6k programs as of 2023 (over 90% of domestic stores). Commercial revenues were ~$750M in 2008 and increased to $4.6B by 2023, a CAGR of +13%. This is more than double the growth rate of the rest of the business at +5.5%. AutoZone still only commands ~2.5% of the commercial market, with O’Reilly ~5% and AAP ~5%.
Auto repair shops that service their do-it-for-me (DIFM) customers source the necessary parts at AutoZone and other auto parts retailers based on availability, convenience and lastly price. Technicians are typically servicing vehicles that are just off warranty (usually 6 years or older) and charge their customers based on the number of hours of labor required to complete the job. Parts availability is important because the quicker these jobs get completed, the space in the shop can be used for the next customer. AutoZone aims to deliver parts that are available in store in just 20-30 minutes and parts at a hub in under 2 hours. Auto repair shops also typically pass on the cost of parts (or mark it up) to their customers, so price is not as big of a factor.
The commercial business is a customer relationship sales channel. So while DIY customers will repeat as customers based on price, service and selection, commercial customers usually require direct sales relationships. AutoZone has recently tasked store managers to become more involved with their commercial customers, making sales calls and learning about their needs. Technicians at auto repair shops typically have a list of stores to call for parts availability and relationships help to getting towards the top of the list.
Top line growth comes from new store builds, price increases and market share gains in both DIY and DIFM. Recently, AutoZone has increased its new store count by an average ~200 stores and relocated 5-10 stores annually. Price increases happen usually to pass on any cost inflation. This is offset by industry wide unit volume decline. Units are shrinking because parts are getting better and lasting longer. The example that AutoZone likes to give is spark plugs. In the past, spark plugs were made of copper and lasted for 30k miles. Now they are made of iridium and last 100k miles or 3.3x longer. But on the positive side, the copper plugs used to cost $0.59 but now iridium plugs are over $10, or an increase of almost 17x.
A lot of AutoZone’s share gains have come at the expense of mom and pop and regional stores, especially in the DIY market. There had been some larger consolidation in the past (O’Reilly acquiring CSK in 2008 and AAP acquiring General Parts International in 2013). The big two, AutoZone and O’Reilly, have been expanding their geographical coverage methodically each year.
Growth in the commercial business has increased the amount of revenue generated at each store. Typically this would increase the efficiency per store (assuming linear distribution costs) and result in higher company margins, but there is an offset to that. The commercial business commands lower gross and operating margins (mid-teens % contribution margins). However, the math should look better from a returns on capital stand point since there are few necessary incremental investments.