AutoZone’s Best Days Are Likely Behind It (AZO)

I’m generally high on auto parts companies, just as I am generally high on anything that sells and distributes parts for just about anything.

AutoZone NYSE:AZOI call these “infrastructure plays” because we humans have created some very complicated systems in many different industries. Those systems are going to break down at some point, possibly even frequently, and need parts to replace the ones that fail.

In the case of the zillions of automobiles on the road both in the U.S. and globally, that means a constant stream of parts are necessary to meet demand. That’s why there are thousands of auto parts stores scattered throughout the world.

That’s also why I think you want to own an auto parts stock in your portfolio. The problem is that they have gotten pretty expensive. Let’s take a look at one of the quintessential auto parts companies as an example.

AutoZone, Inc. (NYSE:AZO) reported earnings on Monday that were pretty strong, although a few things popped up that I didn’t like.

AZO Stock Looks Good, Except for…

AZO Q3 sales came in at $2.5 billion, up 6.5% year-over-year, while same store sales increased 2.3%. Net income was up 8.4% YOY to $309 million, translating to an EPS increase of 13.1% to $9.57 per share. However, that earnings figure was goosed a bit by a 755,000 share repurchase. What’s important is that the $309 million in AZO net income rose 8.4% from $285 million last year.

But this kind of financial engineering makes me cringe. If you aren’t paying attention, you see a 13% EPS increase and think AZO is a growth stock. Instead, it’s really more like a stalwart, growing nicely but not spectacularly. So it’s a bit disingenuous for AZO management to trumpet that this is their 35th consecutive quarter of double-digit earnings growth.

In addition, AZO blew through $515 million in cash to make these repurchases. I’d rather that AZO spent it on something else, especially with Autozone stock trading at such a high absolute price right now. Even worse, Autzone’s cash balance is down to $153 million.

Autozone stock’s debt level isn’t terrible. It has $4.5 billion in debt and is paying about 3% interest on it, which is great. Operating cash flow remains strong at $431 million for the quarter and $680 million through the first nine months. It’s just that management is plowing it all into share repurchases.

There’s nothing bad about Autozone earnings. It’s chugging along just fine with a massive 5,000 store footprint. The problem is its valuation. FY15 earnings are expected to be about $36 per share. The stock closed Monday at $688, putting AZO stock at 19x earnings.

If Autozone stock were generating true EPS growth of 13%, then I might consider paying close to 19x, although I’d feel better about it if growth were closer to 15%. As it is, however, Autozone stock trades at 19x on net income growth of only 8.4%. To me, that puts Autzone stock in the stratosphere.

As much as I’d like to own it, I can’t at these levels. It’s too bad, because on virtually all metrics, it runs a more efficient operation than its competitors.

Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance. As of this writing, he did not hold a position in any of the aforementioned securities. He has 20 years’ experience in the stock market, and has written more than 1,200 articles on investing. He is the Manager of the forthcoming Liberty Portfolio. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.

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