Despite missing earnings estimates, the powerhouse auto parts chain Autozone, Inc. (AZO) increased $18 on Tuesday. The story of AZO stock tells us a lot about the economy and about the stock market in general, so pay attention.
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Autozone did deliver an increase in earnings per share of $10.77 for Q3, which was up 12.5% from $9.57 last year.
You might think that, given how expensive AZO is on both a relative and absolute basis, AZO stock would respond with a big plunge since it missed the $10.96 estimate by a mile.
Didn’t happen.
You might especially think AZO stock would be in trouble because net income, which is more important than EPS, only increased 6% to $327.5 million from $309 million a year ago.
Welcome to the 2016 stock market!
Maybe there’s something buried under the headline numbers that we missed? Well, revenues were up a modest 4% to $2.6 billion, also lagging estimates of $2.65 billion.
Did same store sales explode? Nope. They were kind of lame — checking in at just 2%. Gross margins slightly improved to 52.8%, but that’s a mere 50 basis-point increase.
What’s Really Going on With AZO Stock?
This is just the state of the market these days. AZO stock is really expensive, trading at 18.5x fiscal year 2016 estimates on 6% net income growth. To me, that’s just wildly out of whack, and I wouldn’t go near the stock.
That’s not to say AZO is some dog in a dumpster. It really is master of the auto parts universe with 5,226 stores in this country alone, and another 458 in Mexico. That footprint certainly adds value, but not so much as to make a price/earnings to growth ratio of 3 anything other than crazy to buy into.
Once again, though, take note of another company that is playing the financial engineering game. Autozone management repurchased 687,000 shares for $533 million, at an average price of $775 per share.
How is it good stewardship to spend half a billion dollars on a stock that is easily twice the price it should be? Why not pay that out as a dividend? Because dividends do not reduce share count and thereby lift earnings per share — making unwary investors see 12.5% bottom line growth instead of the 6% it truly is.
The balance sheet holds everything together. With cash of $213 million, and more than $4.5 billion in debt only generating 3% interest per year, there’s no problem there. Plus, AZO generates about a billion dollars in free cash flow every year. So, it’s all well and good.
But with the notion that AZO stock is ridiculously overvalued, we are left with two questions. First, do you short it because of valuation? In the old days, I would. Not today. The market has proven for a long time that it doesn’t care about valuation.
Second, what do the results say about the economy and the auto industry? With 2% comps and 4% sales growth, it seems like things in both categories are okay. Just okay. Not booming, not failing … just okay.
It says that cars are in need of repairs, that people aren’t necessarily postponing them nor are they rushing out to fix things. The results suggest that things are just plodding along.
Which is not a stock I’m interested in investing in.
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 also is the Manager of the forthcoming Liberty Portfolio. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.