Sector
IndustrialsAuto Parts
Background
Freddie Lait is the founder and CIO at Latitude Investment Management. We cover the ways in which AutoZone's customer focus echoes the best of Walmart and Costco, how the business generates some of the highest returns on capital in retail, and dive into their share buyback program.
Cover
Date
November 24, 2021
Episode Number
36
Key Learnings
- Effective capital allocation: AutoZone's impressive performance also comes from its effective capital allocation and industry consolidation strategies. The company has shown a knack for efficient capital management and working capital management
- Look for companies that are not only profitable, but also demonstrate efficient use of capital. ROICs and ROIs should be viewed alongside margins.
- Optimized Inventory Management and Supply Chain: AutoZone's efficient supply chain operations, including local and central inventory optimization, frequent top-ups, and strategic drop-offs, ensure timely availability of parts. Robust supply chain management contributes to operational efficiency.
- Buybacks as Value Enhancers: demonstrates potential for superior outcomes and increased shareholder returns when combined with robust capital allocation. Ofc the buyback has to be done at a low-enough share price!
Key Takeaways and Business Model
- Robust industry dynamics & predictable market trends: The auto parts industry, where AutoZone, despite being a mature industry, experiences annual growth rates of about 3-4% in its addressable market due to increased car usage and aging cars requiring more maintenance. The industry is divided into 'Do-it-Yourself' (DIY) and 'Do-it-for-me' sectors, with AutoZone predominantly focused on the former.
- Successful business model & effective capital allocation: AutoZone stands out among its peers, including Advance Auto Parts and O'Reilly, due to better capital allocation. It bears resemblance to giants like Walmart and Costco in its approach, marked by consistent returns, high margins, and rational industry pricing. Well-executed share buyback program that has led to a roughly 20% compounded annual growth in stock over the past decade.
- Strong Unit Economics and Capital Efficiency: Each store measures approximately 6,500 to 7,000 square feet and they've been opening around 200 stores annually for the last 15 years. The total capital expenditure (CapEx) is around $500 million per year. Breaking this down, each new store costs approximately $2.5 million (including central costs), and generates annual revenue nearing $2 million with a 20% operating margin. This provides a ~16% return on investment (ROI) in the first year, but with subsequent years experiencing growth and the capital depreciating, the return profile improves substantially. The company has a strong return on invested capital (ROIC) at around 40%, which is considerably higher than most retail businesses.
- High Gross Margins and Competitive Advantage: AutoZone boasts high gross margins of approximately 55%, a standout figure compared to typical retailers like Walmart, which hovers around 20%. They are able to maintain these margins due to their service-oriented approach, immediate product availability, and local accessibility. The competitive advantage lies in their customer-centric approach, including knowledgeable staff, prompt service, and even tool-lending for DIY projects. AutoZone's success also relies on their ability to stave off competition from general retailers and eCommerce platforms, which are hindered by the unique challenges of the auto parts industry, such as specialist knowledge and logistical difficulties.
- Effective Inventory Management and Distribution: AutoZone excels in managing inventory at local and central levels. They optimize drop-off frequencies based on return on time and capital. Their inventory network enables them to distribute parts where needed. Private label programs, including the successful Duralast brand, contribute to higher margins. AutoZone owns the distribution of auto parts in the US and Mexico, leveraging vertical integration and controlling distribution to capture more margin.
- Transition to Do-It-For-Me (DIFM): AutoZone, traditionally a DIY-focused business, is strategically shifting towards capturing more market share in the DIFM segment. They have implemented initiatives to cater to local garages and improve their do-it-for-me offerings. Through the introduction of hub and mega hub strategies, optimizing inventory availability, and ensuring sufficient demand, AutoZone has been successful in growing their commercial programs.
- Faster growth in the DIFM Segment: AutoZone's transition to the DIFM segment presents an exciting growth opportunity. The DIFM market is growing faster than DIY, and AutoZone's commercial channel is experiencing a 20% annual growth rate compared to the overall market's 5% growth
Transcript
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