AGB 2023.8 - AutoZone (AZO)
Commercial Growth + Ramp in New Store Openings
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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.
Why is it a good business?
As the leading auto parts retailer, AutoZone benefits from scale advantages and intangible assets. Scale allows the company to (1) operate with lower distribution costs, (2) gain bargaining power over its suppliers and (3) move up market for commercial clients.
While AutoZone’s distribution capabilities still lag behind O’Reilly’s, the company has heavily invested in its distribution centers and mega hub locations in recent years. AutoZone had just 5 mega hub locations in 2015 and now has 98 as of 2023. Distribution advantages help the company get slower turning products (mostly hard parts) that are held at mega hub and hub locations to its customers in a timely fashion. This especially helps the commercial business, which timely availability of auto parts matters much more.
AutoZone has also been able to increase bargaining power and lengthen payment terms over its suppliers as the company has grown. Payables have expanded at a faster rate than inventory, especially over the past 3 years. Scale in the commercial business has also helped the company better gain national accounts. AutoZone now has over 5.6k commercial programs, which is 90% of its domestic store base. National accounts usually require coverage across regions.
Private label is a unique situation for AutoZone because it contributes to more than 50% of total revenues. Duralast is the most well known brand, accounting for more than 50% of hard parts sales, but the company also has ProElite, Shop Pro, SureBilt, TotalPro and others. Duralast has gained a bit of brand equity over the years and the company has been able to offer brand extensions for brake pads, chassis, shocks and struts. Recently, Duralast has helped the company in its efforts to expand the commercial business, so it’s been a source of strength in both the DIY and DIFM businesses.
On the intangible assets side, similar to other retailers with a national presence, brand recognition helps the company in two ways. First, new store openings will be more efficient because there will be more existing customers coming into the stores. AutoZone doesn’t disclose the revenue ramp from new to mature stores, but having studied other growing specialty retailers, the time to maturity should be lower and the steady state sales numbers should be higher. And second, overall marketing costs come down because national advertising is much more efficient vs. local advertising.
Auto parts retailers also benefit from industry tailwinds. First, auto parts (at least based in prior recessions) tend to be counter cyclical. During a weak economy, consumers tend to buy fewer new cars and instead extend the life of their existing cars. Second, cars last much longer than in the past, which implies that more of the useful life of a car is off warranty. The average age of the light vehicles in the U.S. reached 12.2 years in 2022, up from 11.3 years in 2013.
The cohort of 6-10 year old vehicles on the road tends to drive the direction of growth rates for auto parts retailers. This is what happened in 2015/2016, when the number of 6-10 year old vehicles were at the lowest in the U.S. coming out of the great recession of 2008. Since then, there hasn’t been a significant dip in that cohort of vehicles.
Auto parts retailers also have been better positioned against the threat of eCommerce than other categories. Consumers can easily switch to a cheaper online option for categories like accessories and even maintenance. But for parts failures, immediate availability is usually what’s going to drive purchasing decisions. Furthermore, AutoZone’s and other auto parts retailers’ in-store services and knowledge is an advantage to winning customers.
AutoZone has been increasing its eCommerce capabilities in recent years by leveraging its growing distribution network. The company now offers newer eCommerce features like next day delivery and buy online and pick up in store. The eCommerce business still remains a small percentage of revenues and this will likely stay this way, especially with the growth in the Commercial business. At the company’s 2nd quarter 2020 earnings call, AutoZone stated that eCommerce was less than 5% of total revenues.
Returns on incremental capital?
Over the past 10 years, AutoZone has spent 96% of its capital on capex and 4% on acquisitions. Capex spend is related to new stores, relocation/renovations of existing stores, technology investments and building out the distribution network. On the technology front, the company has recently invested heavily in the customer sales experience. AutoZone improved the front-end eCommerce experience, lowered delivery times through efficient distribution controls and rolled out hand held devices to employees.
New stores are opened if AutoZone can find locations that meet the company’s internal hurdle rate. Factors that go into the financial projections include population, demographic, vehicle profiles (7+ years), the potential for commercial business, the strength of the competition in the region and the cost of opening. In recent years, AutoZone has been experimenting with building more mega hubs and increasing the number of mega hubs in a region. This has resulted in much less cannibalization of existing stores than originally thought and has even helped with eCommerce efforts and the commercial businesses in those regions.
The company has increased its target for mega hubs over time. Initially in 2013, they thought that 25-40 mega hubs would be enough domestically. In 2019, AutoZone increased this target range to 70-90. And in 2022, the company increased the target to 200 mega hub and over 300 hub stores.
From a unit economics perspective, unfortunately the company doesn’t give out enough data to estimate those returns on our own. We would need new store opening costs + 4-wall revenues and earnings at maturity. This would also be difficult to measure accurately due to the different unit economics among regular, hub and mega hub stores. Furthermore, mega hub stores tend to lift the sales across the region and help with the commercial business.
The company did mention on its Q4 2023 earnings call that new store ROIC’s are close to 50%, even as both construction and debt costs have increased. The company believes that the runway remains long for the opening of new stores. AutoZone also announced that annual store growth will increase from the current ~200/year to ~500/year by 2018, of which 300 will be in the U.S. and 200 international.
AutoZone’s last two acquisitions were from 2012 and 2014. In 2014, AutoZone acquired Interamerican Motor Corp (IMC) from Wulf Gaertner Autoparts (German company) for $76M. IMC was the 2nd largest distributor of import replacement parts. In 2012, AutoZone acquired AutoAnything for $116M. AutoAnything was an online retailer of specialized auto parts.
We estimate that AutoZone has generated returns on incremental capital between 40%-60% over the past 5 years. There was a spike in incremental returns in 2021 that we excluded from the range, due to the much higher same store sales growth related to the stimulus packages and lock downs related to Covid. Some of that demand pull forward is giving back (though same store sales growth is still positive), but the company’s share gains Commercial should allow it to fare better than other Covid beneficiaries.
Reinvestment potential?
As of 2020, the U.S. light vehicle aftermarket TAM was estimated to be $290B+, with ~$190B for DIFM and ~$70B for DIY. The remaining $30B is for tires, which AutoZone doesn’t compete in. The DIFM market can be broken down to $105B in mechanical and collision parts and $85B in labor. With $12.8B in DIY revenues and $4.6B in commercial revenues, AutoZone has ~18% share of the DIY market and ~2.5% of the commercial market in 2023. The market has likely grown since 2020, so it’s not wrong to assume that AutoZone’s share is slightly below those numbers.
Looking at the TAM in terms of store count is also useful. There are over 40k+ auto parts retail locations in the U.S. With 6.3k domestic stores as of 2023, AutoZone has almost 16% market share in terms of stores. The top 4 auto parts retailers have 22.5k domestic stores, which more than 50% of the market share. Over the past two decades, a lot of the store growth from the top 4 players have come at the expense of mom and pop locations.
AutoZone recently set a new goal of opening 500 stores per year starting by 2028, up from ~200 stores per year over the past decade. AutoZone believes that the high ROICs and profitability per store coming out of the pandemic is sustainable due to the ramp up in the commercial business. This has allowed for new growth areas even in the company’s more mature U.S. markets (at least on paper).
Internationally, the company still sees ample opportunities in Mexico and Brazil as well as in other new markets. The company has been in business in Mexico for over 20 years and the playbook is very similar to that of the U.S. The car parc is a bit older in Mexico, many of which are U.S. cars. The profitability and return profile of the Mexico operations have not recently been disclosed.
Brazil has been a slower ramp and the company is still losing money in the region. A lot of that has to do with the low store count vs. the infrastructure required, but AutoZone aims to figure it out since the company has only been in the region for less than a decade. The car parc in Brazil is comprised of smaller cars with much smaller engines. AutoZone estimates that Brazil can account for over 1k stores at maturity.
With a reinvestment rate between 15%-25% and a return on incremental capital between 40%-60% (excluding 2021), we estimate that AutoZone has increased its intrinsic value between 9%-10% over the past 5 years. The reinvestment rate should move higher from 2025-2028 when the company ramps up its new store openings.
Because the company generates a fair amount of excess cash, AutoZone elects to return cash to shareholders in the form of buybacks. And because intrinsic value has steadily increased while multiples have ranged between 12x-18x P/E for the past decade, the buybacks have resulted in a stock price performance much higher than the annual growth in intrinsic value. As of 2023, AutoZone has purchased over 100% of the shares outstanding since the start of the buyback program in 1998. The share count 20 years ago was 86.4M and is now only 18.6M.
What else is important?
AutoZone vs. O’Reilly
What great about AutoZone’s position in the industry is that there is a playbook that the company can easily follow. O’Reilly has taken the lead in heavily investing in distribution capabilities, including the hub and mega hub model. O’Reilly calls them super hubs. What’s interesting is that even though AutoZone is a few years behind in terms of infrastructure and distribution capacity, they’re still able to take ample share in the commercial market. Some of that has to do with AutoZone leveraging its already well established DIY business and private label brands. But it does seem like these two companies can both take market share because auto parts retail still remains very fragmented.
What about EV adoption?
EV adoption is a concern for auto parts retail, as with most parts of the automotive value chain, because EVs tend to have fewer mechanical parts and require less maintenance than internal combustion engine (ICE) vehicles. This will likely be a headwind that the industry will have to deal with eventually, but there are a few mitigating factors for now.
First, auto parts retail already has a natural 5+ year buffer due to the warranty length on new cars. Second, EV share of new vehicles sold per year is still very low. Estimates for differ among various industry sources, but EV share among new vehicle sales was likely somewhere in the range 3%-7% in 2022. It will take a while for this to impact the 6-10 year old car parc.
Third, the auto parts retail industry has already been experiencing annual declines in units for quite some time. The offset to that is price, especially since the parts now last much longer than in the past. And fourth, specific to share gainers AutoZone and O’Reilly, there is still ample room to grow vs. mom and pop and regional auto parts retailers.
Is the Covid bump sustainable?
Auto parts retail may be one of the few Covid beneficiaries that actually sustains a lot of its share gains. Specific to AutoZone, it’s the ramp up of the commercial business that has the most promise. The company was able to grow its commercial programs and build relationships with professional body shops during this period. AutoZone is banking on growth to continue in this segment, which is part of the reason for the company’s ramp of new store openings. It’ll be interesting to see how effectively the company can continue this growth trajectory in the U.S. as we’ve already seen same store sales decelerate quite a bit (albeit off of high growth comparisons). AutoZone does have the faster growing international segments that have continued to exhibit high same store sales growth rates (1.7% domestic vs. 14.9% international in Q4 2023).
To put the growth in perspective, in 2023 average weekly sales in the domestic store base has increased 33% vs. 2019. And operating profit has increased 61% vs. 2019 due to operating leverage. The company estimates that it gained 10% of market share from the early stages of the pandemic and continues to add to that lead.
Optionality
International expansion will contribute more to growth in the future as the company builds out its network of stores in Mexico and Brazil. It still remains to be seen if Brazil and Mexico will return similar economics to that of the U.S. but we should be able to see the result of all the investments over the next few years. Further expansion into the rest of South America could be an option for the company in the future. Canada also remains an option as its car parc is a similar size to that of Mexico.
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Good article!
I wonder in a recession what can happen...