Auto parts stocks have been on a roller-coaster ride this past year and companies like AutoZone, Inc. (NYSE:AZO) have put out erratic earnings reports.
Sometimes it seems like the sector is a disaster, and other times it seems like things are just fine. In the morning, shares of AutoZone will be on the move again because AZO earnings will have just come out.
So what are the forces at work here and what is the play for AZO stock?
Pros and Cons of AZO Stock
The bull case for AZO stock has a few points. First, take a look at the plethora of new and remanufactured parts and supplies it offers: A/C compressors, batteries and accessories, belts and hoses, calipers, carburetors, chassis, clutches, CV axles, engines, fuel pumps, fuses, ignition and lighting products, mufflers, radiators, thermostats, starters and alternators, and water pumps.
Then there’s the complete set of fluids, brake parts, filters, sensors, refrigerants, and discretionary products like air fresheners, cell phone accessories, drinks and snacks, floor mats and seat covers, protectants and cleaners, sealants and adhesives, steering wheel covers, stereos and radios, tools, and wash and wax products.
Everything you could ever want for your care is available at AutoZone, and that puts it firmly in the superstore category.
But here’s the thing about all these parts and accessories: people will always need them. There are roughly 250 million cars on the road in the country, and AZO has over 5,300 stores to service them — not to mention another 500 in Mexico.
Cars always need maintenance. They always need parts because cars wear out. They are a depreciating, deteriorating asset. People need cars and need to have those cars maintained. Autozone stock has soared over the years because it has economies of scale. It can negotiate lower prices with manufacturers.
The other thing about AutoZone is that it is theoretically recession-proof. If new cars stop selling, then used car sales pick up. In fact, used cars will need more maintenance and attention.
Autozone has a consistent business, consistent free cash flow and it’s firmly entrenched in Peter Lynch-stalwart territory with a long-term growth rate of about 10%.
On the bear side, however, there are a few things to be mindful of. New car sales are having a lousy year. In November alone, new car sales fell 10% over last year. Small vans and minivans fell 10% and 12.7% respectively. The rest of the light-duty truck segment rose about 4.4%.
On the used car side, Q3 saw a decline of about 300,000 cars, or 3.3%. Yet the 9.36 million sold is the same as it was in Q3 of 2012. This actually speaks to the bullish case, in that there are always going to be cars out there to service. What supports the bear case, however, is that growth is of some concern.
Another issue is that lease returns are increasing, meaning that used cars under three years of life are filling the market — but the cheaper cars are those over three years. So demand is mismatched with supply.
There’s also the issue of valuation. With $1.28 billion in TTM net income, AZO stock trades at 16x earnings on 10% growth.
Bottom Line on AZO Stock
So what do you do with AZO stock? Because the auto parts sector is fickle, we saw AZO stock fall to $500 earlier this year. If that happens again, I would buy without hesitation.
Likewise, you don’t have to wait for that. You can divide up possible purchases and nibble every time the stock falls through certain prices like, say, every $25 or $50.
I feel AZO shares are expensive now and I happen to be a value investor, so to each one’s own.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance and is the Manager of The Liberty Portfolio at www.thelibertyportfolio.com. He does not own any stock mentioned. He has 22 years’ experience in the stock market, and has written more than 1,600 articles on investing. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.
