AutoZone, Inc. (NYSE:AZO) beat high expectations going into earnings. For the first quarter of 2018, AZO earnings came in at $9.96-per-share, 15 cents above estimates. Revenue came in at $2.59 billion, $50 million higher than expected — a 4.9% year-over-year increase. However, AZO stock still faces some notable challenges.
For example, same-store sales within the U.S. only rose 2.3%. Given the recent stock price increase and finance-related issues, current investors should treat this run-up in AZO stock as an opportunity to take profits.
To be sure, this earnings report has provided some welcome relief. AutoZone stock rose by nearly 4% the day before earnings in anticipation of its earnings report. Now with earnings released, the AZO stock price has been bid even further upward.
The increase in AutoZone stock comes despite some unique financial metrics. The Memphis, Tennessee-based auto parts retailer appears to hold up well against competitors when it comes to value.
Advance Auto Parts, Inc. (NYSE:AAP), Genuine Parts Company (NYSE:GPC) and O’Reilly Automotive Inc (NASDAQ:ORLY) all have price-to-earnings ratios at about 20. The P/E ratio for AZO stock remains at about 16. GPC has become the market leader with $15.3 billion in sales in its previous fiscal year. AZO remains second in sales at just under $11 billion.
That lower valuation could be the result of a mixed financial picture. On the surface, most of the financial metrics indicate a record unlikely to either attract or repel investment capital. Annual revenue growth has averaged almost 5% over the last five years. The company has reported average annual revenue growth of 6.6% in the same period. The PE ratio stands just above 16 currently and has remained in a 12-20 range for more than ten years.
Looking deeper, one balance sheet metric that’s both odd and of great concern is the current ratio. Despite steady profits, the company’s current ratio remains below 1. A low current ratio often indicates a company has trouble meeting its current expenses.
What makes this odd is that most companies who have a current ratio below 1 lose money. AZO stock earns profits. What places its current ratio under 1 is high levels of accounts payable. For fiscal 2017, AZO reported accounts payable of $4.169 billion, even higher than $3.882 billion in inventory and the modest $293 million in cash.
Also, the low current ratio has led to a negative book value. Between the $4+ billion owed to suppliers and the over $5 billion in long-term debt, AZO owes over $9 billion. The debt liability alone almost exceeds the value of AZO’s total assets.
Furthermore, management appears to have prioritized the stock price over the health of the company. Management has applied profits to share buybacks instead of the balance sheet for several years. Since the beginning of 2016 alone, total shares have fallen from 30.21 million to just 27.49 million today, which is a 9% reduction in two years.
It is these factors that drove the book value of AZO stock to a loss of $1.428 billion. While this shows an improvement over the $1.788 billion from 2016, having a company with a negative book value places the company in a dangerous position.
Earnings profits in a recession-proof business like auto parts helps reduce this danger. Still, that only staves off issues in the near-term. Paying down accounts payable to increase the current ratio and the book value would likely be a more logical step to improving the company’s financial security and bolstering investor confidence.
With the management team engaging in behavior that endangers the stability of AZO stock, stockholders should sell despite the positive earnings report.
AutoZone has over 6,000 worldwide locations and has a strong following in a recession-proof business. However, management’s tendency to prioritize share buybacks has given the company a negative book value. This extreme push for share buybacks should give investors pause.
Although investors should watch for balance sheet improvements, investors should avoid AutoZone stock as long as the negative book value remains a reality.
As of this writing, Will Healy did not hold a position in any of the aforementioned stocks.