by Ivan Martchev | March 27, 2012 1:31 pm
At the end of the latest reported quarter, auto parts retailer AutoZone (NYSE:AZO) had 38.95 million shares outstanding. This number means little on its own, but when you consider than since 1998 the company has been meticulously repurchasing stock every year — and in the process has managed to retire 128.8 million shares — eyebrows naturally rise.
“Here comes AutoZone with yet another buyback,” I thought as the news wire for the latest board authorization to repurchase $750 million worth of stock passed on my computer screen.
I had known about AutoZone’s regular buybacks for some time, but I had not considered the cumulative numbers of shares retired. When I looked at the number, I was surprised to see that
management had retired 70% of shares outstanding since this rather interesting financial experiment began nearly 14 years ago.
Any company’s share price should feel the disappearance of more than two-thirds of the float, even if business stays flat. In this case, AutoZone grew notably as the number of shares shrank dramatically. Management did a lot to break into new commercial markets, which resulted in an acceleration of sales growth. Over the past 10 years, sales show a compounded annual rate of growth (CAGR) of 5.3%, a five-year CAGR of 6.3% and a three-year CAGR of 7.3%.
Because the share count shrank consistently as the company grew, earnings per share growth was much higher than any other measure of profit growth. This is why EPS show a 10-year CAGR of 23%, while EBIT has a 10-year CAGR of 6.3%.
“So why doesn’t everyone do what AZO does?”
I got the question when discussing AZO’s above-mentioned strategy. When looking at other companies in the same industry, one discovers that AZO has the highest year-over-year revenue growth (8.6%) and the highest gross (51.22%) and operating margins (18.67%). Yet the shares — at 17.66 trailing and 14 times forward earnings — are not valued above the industry average. It does not appear that anyone else in the industry has the cashflow to try such share shrinkage as aggressively.
If no one in the auto parts industry can pull it off, surely the money manager that helped engineer this financial maneuver — Eddie Lampert of ESL Investments (general partner of RBS Partners LP) — has found some other retailers that can replicate this. Perusing RBS Partners’ latest 13F-HR filing shows his latest concentrated positions.
One thing that jumps out immediately from the filing is how much Lampert has cut his bet; the AZO position has “only” 2.98 million shares remaining, while as far back as 2008 the same fund had 22 million shares, which is normal under the circumstances. There are other huge positions in retail stocks, and some of them are trying to pull off the same trick: increase profitability while shrinking shares outstanding.
Earlier this month, Big Lots (NYSE:BIG) — a 1.65 million RBS Partners position — reported record fiscal 2011 total sales of $5.2 billion, as well as a fifth consecutive year of record EPS. This resembles the AZO situation because the company invested $359 million to repurchase 11 million shares (approximately 15% of outstanding shares as of the beginning of fiscal 2011). Big Lots has only about a third of AZO’s operating margin (6.64%), but the company has no net debt and the ability to keep doing a similar share shrinkage with a current float of 62.62 million shares.
With a P/E of 15, the shares of America’s largest closeout retailer appear not that expensive, and it will be interesting to see how the ongoing share shrinkage plays out in this case.
Another huge retail position is The Gap (NYSE:GPS) with 31.17 million shares in RBS Partners’ portfolio.
Similar to AutoZone, The Gap has done a lot to return cash to shareholders. The company recently approved a new $1 billion share repurchase authorization, as well as an 11% increase in the annual dividend per share for 2012. Since October 2004, The Gap has distributed about $13 billion in cash to shareholders, spending more than $11 billion in share repurchases to retire 570 million shares (in fiscal 2011 alone, GPS repurchased 111 million shares for $2.1 billion). Given that The Gap currently has a market capitalization of $12.91 billion, the company has distributed its whole current market cap to shareholders since 2004.
The above was highly necessary to (try to) revitalize the share price, as The Gap has a five-year sales CAGR of –1.97% because of a big strategic error, in my opinion. Banana Republic is The Gap’s upper-scale division that tries to sell high-quality merchandise. It was doing well until The Gap decided to develop Old Navy, which caters to less affluent consumers — in effect being a company with higher-end brands that actively targets the low end of the market. Since I bought two dress shirts from Banana Republic in 2008 and discovered that their quality was more appropriate for an Old Navy label, it took me three years to go to one of the company’s stores again. Given the five-year negative sales growth, it looks like I am not the only one to have voted with his feet.
Given the unfortunate Old Navy detour, it would be difficult to turn around The Gap and refocus it to be more upscale again. This might be a retail business, but fashion is very different from auto parts. Still, this is another example of a very aggressive share buyback.
The last big bet on retail in the RBS Partners portfolio is Sears Holdings (NASDAQ:SHLD) with a current 48 million-share position. How putting two dying retailers in 2005 in the same company — Sears and Kmart — would make a more successful business operation was difficult to understand at the time, and now the skeptics have been vindicated. Cost-cutting and streamlining the business worked for a while, then the hazy strategy caught up with this problematic conglomerate, resulting in 19 consecutive quarters of declining sales.
Sears Holdings also has bought back a lot of stock — $6.4 billion, to be exact, as the program commenced in 2005. But it is one thing to be buying back stocks as the business is growing in a healthy manner, like with AutoZone, and quite another when the company is struggling to turn it around.
I am not sure how this one gets resolved. They say Sears’ real estate is where the value is, but that would be like trying to make lemonade out of a lemon idea; I seem to remember the original intention for the merger with Kmart was to compete with Wal
It appears that AutoZone’s success is (nearly) impossible to replicate, even for Eddie Lampert.
Ivan Martchev is a research consultant with institutional money manager Navellier & Associates. The opinions expressed are his own. Navellier & Associates holds a position in AutoZone for its clients. This is neither a recommendation to buy nor sell the stocks mentioned in this article. Investors should consult their financial adviser prior to making any decision to buy or sell the above mentioned securities.
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