AutoZone: Digging Into The Valuation

After reporting Q3 FY 2015 earnings mostly in line with analyst estimates, AutoZone, Inc. AZO appears appropriately valued at $688.43. Prudena's models estimate a share value 5.4% below the market price, and earnings growth would have to accelerate substantially to push estimated share value more than 10% above the market price.

2.3% same-store sales growth is unlikely to make value investors assume earnings will accelerate from a period which has seen average automobile age expansion alongside improving household income.

Prudena's models estimate that AZO shares are worth $650.89, assuming a required rate of return of 6.54%. Estimated forward EPS is $35.85 for fiscal 2015 and $40.22 in fiscal 2016, based on consensus analyst estimates. $650.89 implies long term residual earnings growth of 0.77% and long term EPS growth of 6.5%.

The current market price of $688.43 is 5.4% above Prudena's estimates and falls within the distribution from their Monte Carlo simulation. $688.43 implies 1.09% long term residual earning growth and 6.74% long term EPS growth. Prudena's models indicate that AZO is appropriately valued, and long term earnings growth would have to surpass 7% for the Monte Carlo simulator to estimate share value more than 10% above the current price.

AutoZone's trailing average 10 year revenue and income growth rates have hovered around 5.5% and 6.5%, respectively.

The Bull Case

AutoZone has been a stable player in the auto parts market, and has generally posted operating metrics similar or superior to peers. AZO has higher profit margins and ROA than Pep Boys PBY and Advance Auto Parts AAP. While AutoZone was reporting a slight earnings beat for the most recent quarter, Advance Auto Parts missed earnings estimates and cut guidance.

AutoZone's inventory expansion in Q3 FY 2015 also indicates optimism among management at the firm.

Lower gasoline prices lead to higher average miles driven per person, which will catalyze AutoZone’s future sales. The average age of vehicles is also trending upwards in the U.S, which is a bullish signal for auto part and maintenance demand. Currently, the average age of vehicles on the road stands at 11.4 years, which is expected to reach 11.7 years by 2019.

Management is also taking steps to access the commercial market. AutoZone’s track record with buybacks is another reason to remain positive about the stock’s price, which will be supported by repurchase activity.

The Bear Case

AutoZone is a mature specialty retailer operating in a highly competitive market, evidenced by 2.3% same store sales growth reported in the most recent quarter. Cyclicality and competition are threats to high long term growth targets. A recovery in new car sales should put downward pressure on average car age, and average car age is positively correlated to demand for replacement and maintenance parts. AutoZone generates more than 80% of its revenue from failure and maintenance related sales.

Despite stable growth numbers and margins, the company still is not the highest growth option in their industry, having posted inferior growth numbers to O'Reilly ORLY and Advance Auto Parts.

Conclusions

AutoZone reported Q3 FY 2015 revenue of $2.5 billion and $9.57 in diluted EPS vs. consensus estimates of $2.5 billion and $9.52. This compares to $8.46 EPS in the prior year period. These results are essentially neutral, having slightly topped estimates on the bottom line. Forward estimates are modestly positive and analyst recommendations are generally neutral.

Longer term average revenue and earnings growth will have to accelerate to yield the residual earnings growth implied by the current market price, though only modestly. AutoZone is one of the more attractive options in its industry, but the fundamentals and consensus estimates do not suggest that $688.43 is an attractive entry point for fundamental investors.

About Prudena

Contributors: Ryan Downie, Soid Ahmad

NOTE: The Morning Monte is high-level, and any investment requires a deeper analysis than is presented here. The comments in the Morning Monte are intended to help guide your research and ground you in the fundamentals of the company. In no way should the comments in The Morning Monte be taken as advice to buy or sell a particular equity. Some of the statements are forward looking. As such, these statements are speculation--so beware! The comments represent the views of the author and are not necessarily the views of PRUDENA™.

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