Chit Chat Stocks - AutoZone (Ticker: AZO) Not So Deep Dive

Episode Date: August 15, 2023

AutoZone, Inc. (AZO) is a retailer specializing in automotive parts and accessories, with a vast network of stores serving do-it-yourself and professional customers, but also navigating challenges from competition, shifts in consumer behavior, and technological advancements in the automotive industry. At the end of the month, we will publish an Arch Capital episode that will cover the company: Sprouts Farmers Market. Listen closely as Brett and Ryan go through the history, financials, and future prospects of WeWork. Enjoy the show! ****************************** Subscribe to our Substack to receive free show notes and charts that go along with every episode: https://chitchatmoney.substack.com/ Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney Contact us: [e-mail] Timestamps Company Background | (3:22) Industry | (14:33) Management & Ownership | (22:15) Earnings | (28:05) Balance Sheet | (32:32) Valuation | (35:00) Our Analysis | (36:21) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, hosts Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or a recommendation. Now, please enjoy this episode. Welcome into Chit Chat Money. My name is Brett Schaefer, and I'm joined as always by my co-host, Ryan Henderson. This is our Tuesday episode. It is our not-so-deep-dive episode, and we are

transitioning to a new month. So that means a new theme, and we're doing share cannibals. So that means it's companies that have greatly reduced their share count over the last, say, decade, two decades, whatever. We're starting off with the king of buybacks, AutoZone. It's going to be a really fun episode. We're going to analyze the stock. We're going to analyze future growth opportunities, risks, financials, history, ownership, management, all the good stuff. But first, before we get to the episode, I want to say, if you want good charts, any charts any good show notes any good links to further reading subscribe to our newsletter where you'll get free access to the show notes for every episode that we do on tuesdays it's a great way to

supplement any research or any you know any of the numbers you may have forgot it's really good i think when we do it we like to you know write all the stuff down and then record the episode it's really good to kind of get everything locked into our brain i think for listening to it you can listen to it and then read the stuff. You can really help retain all the information. But before we get to it, Ryan, you're going to introduce AutoZone, but first you have a poll, right? Another poll for the listeners. So why don't you explain that? Yes. And I know people like to skip our intros because I can see it in the data. But if you're listening now, please stick around after the episode because there's going to be a

survey um and i know people might want to answer these dishonestly or however they want and it's just so you know we can't see anyone that's answering it we can only see the responses so just the percentages in terms of whether uh basically whichever one's chosen the most Um, but we're going to be asking today, whether or not you have more than $25,000 in savings, uh, that includes investment accounts, bank accounts, anything saved, just if you have more than 25,000, just so you know, just full transparency, we do these polls because we are trying to get a better sense of who our listeners are. Um, that way we can also provide data to advertisers so we can get better advertisers. I know people are probably thinking,

well, maybe I don't want ads, but if you want us to keep doing the show, if you enjoy us, or even if you don't enjoy us, but you want to hear what we have to say next, please go ahead and give a response. All the data, all the feedback really helps. So I guess with that, let's get to AutoZone. Yeah. Okay. All right. Let's start with what they do. I know I've been rambling there for a while. Am I forgetting anything, Brett? no i don't i don't think so um newsletter poll i think let's get right into it we're gonna do share cannibals we'll try to focus on the value of repurchases this month i think maybe that could be a theme but we're definitely gonna be talking about that throughout this episode

yeah and i think uh i guess i'm pretty sure the poll will only show up if you're on spotify so um just if you're on apple disregard but let's talk autozone they are one of the i would say premier share cannibals over the last 20 years i have to imagine they're probably in top five most shares repurchased as a percentage of their overall shares outstanding in the last 20 years i'll say it right now share count outstanding since the year 2000 so the turn of the century shares are down 86.4 percent so um let's talk about what has been the blueprint that's allowed them to do that. AutoZone is the leading retailer of auto parts and accessories in the United States. These include items ranging from critical parts, so stuff like batteries and

fuel, or sorry, fuel pumps, like actual parts, to maintenance things, things like oil, fluids, coolant, that kind of thing. And then even discretionary items, stuff like air fresheners, mirrors, protectants. If you read the newsletter, I jotted down, or they have basically a little graphic of all the categories. They have failure categories, maintenance categories, and discretionary items. They include all the different kinds of things they sell, but 84% of the products that are sold at their stores or as a part of their sales are considered either failure or maintenance categories. So these are the things that people basically need to drive their car. And there are two groups that they sell to. There's individuals, and then

they call it, and the individuals, they call it do-it-yourself. And then there's the garages, which are, it's mostly commercial customers, and they call this the do-it-for-me. So when we talk about the do-it-yourself customers, these account for 71% of AutoZone's revenue, so the majority. And for individuals, AutoZone tends to provide more than just the sale of goods. Customers come to AutoZone because they get specialist knowledge. So if you show up, you're like, what do I need for this problem with my car? And AutoZone can sell it to them because they have a really wide range of inventory. And then they can provide them the tools to actually install it if needed.

So they actually have a program called the loan a tool program. So say someone comes, their car's back at home, they show up to an AutoZone store and they need a specific tool, which the AutoZone employee will typically tell them, hey, in order to install that, you're probably going to need this. They will give it to them, have them put down a deposit. And then if they bring it back within 72 hours, they get all that money back. So they'll loan it to them for free just as kind of customer service. On the commercial side, it accounts for about 29% of sales,

but it's growing quickly or it has grown and kind of outpaced the do-it-yourself category. So these are sales to local or even national repair garages, dealers, other types of service stations. Basically, commercial customers can order any inventory that they're going to need, and they will typically do it on kind of online. So AutoZonePro.com or through the mobile app, and AutoZone will actually deliver it to them from their more than 350 hub and mega hub stores located throughout the U.S. This segment really reminds me of Home Depot's pros business, where for AutoZone, it's not its own supply chain, but it is just a very different model than the do-it-yourself, come pick up in store kind of segment. So those are the two businesses. As for their physical footprint, AutoZone has just over 6.2 thousand stores in the US, 700 stores in Mexico, and 83 stores in

Brazil. On the last conference call, they actually asked about Brazil and he said, our test, basically there was a test period where they were testing out the market in Brazil. He said, that's over. This is going to be a market that we invest in moving forward. And then each of these stores is around 6,500 square feet and they stock the stores with tons of inventory. So unlike other retailers where the motto is, and I stole this from the, what's it called The Business Breakdowns Show, where someone came on, he talked about AutoZone. He said, commonly, retailers have this motto of stack it high, sell it cheap, sell it often. AutoZone doesn't turn over its inventory all that often because they have to have a wide

assortment to meet anyone's particular needs. And just because they don't turn it over that often, the inventory, it's not necessarily that bad. Typically, you'd think that's not great for a retailer but the inventory doesn't go bad for the most part these are like parts that are going to be used for cars for a long time and they have long accounts payable periods to their vendors so they actually have um a working capital advantage because of that and i think that just about summarizes it they have some proprietary internal um databases some internal systems that they're yeah it's called all data right something like that yeah and there's one that's called z net I think as well, which is like their proprietary catalog for looking up parts for different models

and makes. And there's just thousands of different parts and things that need to be stored in their hubs and their warehouses and their actual stores. And they need to be looked up by all these specialists. So I think one of the key points that we'll talk about through this episode is that there are needs you need to, with the majority of your customers, you have to hold their hand. Yeah, that's exactly right. And I think that's been a huge reason that they've been so successful is the customer service aspect is real. These are people that the auto zoners, as they call them, are actually kind of car enthusiasts. They understand the car parts. Most people do not. And so having that element of customer service and the kind of the specialist

knowledge that people lack really allows them to kind of, I think, provide a service element beyond just the goods they sell, which I think has allowed them to have the 50% gross margins that they do. But let's talk about the history because it's kind of an interesting origin story here. Actually, AutoZone was originally developed out of a wholesale grocery company called Malone and Hyde. Malone and Hyde sold all sorts of items. And then after the original founder's son, Pitt Hyde actually introduced auto parts to the business. So it was kind of just initially a part of Malone and Hyde. That was around the late 1970s, but then they began to see pretty good success with it. So Malone and Hyde, which was actually publicly traded on the New York Stock

Exchange, they'd had several acquisitions that were getting blocked and they were trying to diversify their business. So instead, Pitt Hyde, who is really the founder here, decided to spin out the auto parts store and make it his own. Well, not make it his own, but make the auto parts business its own segment. And so in 1979, they opened their first store in Arkansas called the Auto Shack. This was kind of one of the first real self-service auto parts stores because a lot of the stores at the time were just like these repair garages where you weren't really going in and buying anything yourself. But they started to add stores pretty quick. The concept caught on. And in 1986, they rolled out their first in-house brand,

Duralast. Now they have a number of in-house brands. And then a year later, apparently they had a dispute with Radio Shack. So they changed their name to AutoZone. And around that time, Pitt Hyde decided to take Malone and Hyde private. He sold the grocery segment, kept the auto business on its own. So basically spun it off as his own thing. And then I think three years later, he re-IPO'd AutoZone on its own. So throughout the 90s, AutoZone was really in this expansion mode. They reached a thousand stores in 1995 and they kept acquiring other companies and they would acquire, I think, basically these big chains of repair garages or competing stores. And they would just reformat the stores and kind of reconfigure them

into AutoZone stores. In 1997, Pitt Hyde retired. It wasn't until 2005 that the CEO, which we're probably going to spend some time talking about today, Bill Rhodes was his name, I believe, stepped in. He worked with the company for a while, but he didn't become CEO officially until 2005. And then around the late 1990s was the first time the company really instituted their share buyback program. Since that time, it has been just one of the probably most successful compounding stories of the last 25 years. It's been consistent and steady growth. It hasn't been anything explosive, but they've been pretty much reasonably valued for 25 years. And they've used that to their advantage to bring down the stock consistently every single year.

And something that was talked about on that Business Breakdowns episode was people think about the compounding to the upside, so the compounding effect of growing revenue 15% a year, yada, yada. But they don't really think about it to things like a share buyback, where when you've reduced the share count by 90%, you've actually increased the per share earnings by, what is it, tenfold probably? Tenfold, yeah. And as you do it again, which AutoZone may be able to do over the next probably 12, 13 years, that's a hundredfold, even if the business hasn't grown. Yeah. So we're really starting to see, I guess, the byproduct of that because earnings per share has just been climbing over the years. And I got to say, this is a good hunting ground. Just when you're looking for share cannibals, typically, if you've been able to acquire 90% of your own stock over 20 years, you've probably got a pretty durable business.

That's right. And it probably generates a lot of cash because you're doing it unsustainably. there's some examples like that where well bed bath and beyond you know filed for bankruptcy the let's hit the industry i guess yeah we'll hit buybacks a little bit more later and probably throughout this month but i'll hit industry and competition autozone as ryan mentioned focuses on the diy part of the market but they're the largest player within this and the market is huge even in the united states there's hundreds of billions of dollars spent on automotive repairs each year This is a fairly mature business for AutoZone, the DIY segment with over 6,000 stores as of the last quarter. However, and I made this as a bold note in the show notes, the industry is still very

fragmented. AutoZone, even as the leader, as the leading kind of chain, was estimated to have only 14% market share in the US, advanced auto parts at 6%, and O'Reilly auto parts at 9%. So you combine that, they're just under or maybe around, could have grown a little bit till today, 30% market share of an industry that kind of lends itself to consolidation. It has been slowly consolidating to these players over the last few decades. I don't think it would be shocking to see these three players hit 50% share in the United States within 10 years. Do you think that's crazy? It doesn't seem crazy to me. I think that's kind of an opportunity that you might, we talked about on the power hour before recording this, that you were worried

about the segment being more mature in the U S and I think this might be an example as it's not as mature as people might think. Yeah, I think that can be right. And it's maybe not, I'm curious what makes up the rest of that market. A lot of local, a lot of local. I looked at a stat of, there's just a ton of fragmentation across this market, which you could spin as, okay, well, if it hasn't consolidated yet, why not? But I think it's more of a slow consolidation where AutoZone still has a lot of opportunities to take share if they can continue with their solid execution as they have for the last two decades.

Yeah, we're just becoming like a supplier to the local chains. That's right. I mean, I think that's basically what they're doing with the commercial segment is becoming one of the primary vendors for a lot of the repair. I mean, a lot of the repair stuff, too. Yeah, I don't know exactly. I think they're really trying to, I think that's a different part of the market, but I get what you're saying, where it's a little bit of a gas station, sell it to, you know, stuff that's just like, it's competitive, but they could also maybe act as a wholesaler.

Yeah. Yeah, exactly. And yeah, it is weird to calculate all that stuff, but to go to the next part, AutoZone, as Ryan mentioned, operates in two international markets, Mexico and Brazil. Mexico has 713 stores, so fairly large, but much smaller than the U.S. at 6,000 or over 6,000, and Brazil is very early at 83 stores. Management mentioned that Brazil currently has negative return on invested capital, while Mexico actually has a higher return on invested capital than the United States business. Here's a question I have.

Do you think these are two great choices for them? One, large countries, two, good automotive markets there, at least in Mexico. I think this could be a good way for them to play the decade of mexico as people have been talking about for the 2020s does that make you a little bit more attracted to this business given that they're still you know the the margins or the returns seem to be better in mexico and there's still a long run away for them to reinvest yeah i like that the mexican market looks so promising for them and i also like the way they go about it because they're not willy-nilly yeah they they really test the markets i mean they were even very open they said listen we have negative returns on the capital we're currently deploying

in brazil but we think there's a line of sight to it becoming positive um with mexico it's almost the opposite i mean they're getting better returns than they see in the us well they're not just willing like they've been in mexico for a long time they're not opening stores rapidly they're opening them consistently 140 a year pretty much i mean it really is like they they just replicate the same exact model. And I'm sure they've learned from their mistakes in the US or their successes in the US that what are the best practices there. But yeah, I like the way they've been pragmatic in opening up new stores and kind of patient, not pushing it too much when they see the opportunity. But so far, the international rollout has looked pretty successful.

Yep, for sure. And that's something definitely for investors to watch over the next decade or so. other growth opportunities. I guess the industry is strangely got a lot more growth opportunities than maybe you'd think at the start. So the automotive repair market is seeing a tailwind because of the rising age of vehicles on the road. As the age of vehicles grow and new cars are more expensive, we see in the average age, especially in the United States, just get older and older and older. I have a good graphic here that I'll share for the people that watch, but it's pretty easy to describe. So if we look at the cars segment, we'll just stick with cars in 20, say right after the great financial crisis, the average age on the road was about 10.8 years.

And then if you go to 2022, we're at 13.1. So the average age on the road is going up. And that means more and more on average are going to the auto repair shop. And what I think is interesting looking at this industry stuff and maybe i'll actually i'll talk about commercial first so as ryan mentioned they are going into the commercial market that's another opportunity for them the dfim do it for me stuff don't really have any numbers there but if you kind of sum it up they have growing industry taking share uh they said opportunities in mexico and brazil and another opportunity in commercial but if you look back at value investors club there's some reports from 2000 and some of the stuff is aged really poorly because they talk about the initiatives

into commercial in 2000 as well so maybe i would take that with a big grain of salt as how well autozone can succeed in this market but some things that they also talked about were you know the threat of e-commerce which hasn't materialized at all and i think there's key reasons for that because you don't really trust a broad-based retailer with the specialty needs of an automotive repair they also talked about the quality of new cars and how they won't need any repairs which has aged laughably poorly they've gotten more complicated and even harder to repair and they also talked about um what was it oh less people doing diy which has happened and people see that as a threat today but it didn't impede autozone from growing because the entire market

saw so many tailwinds out there. So I thought it was quite interesting that a lot of the bear cases that were there in 2000 are still there today and the stock's up probably a hundredfold. Yeah, it's always difficult when you put out

some of those short reports on VIC. It was a long, to be fair, they were long reports, but they were talking about the risks that they're worried about. So, yeah. Yeah, I mean, it's,

I guess the other one, I don't know if you talked about this, but cars on the road. The number of cars on the road continues to go up, I think, by about 1% a year as well. Yeah. And with the average age in Mexico at 29, I think I would not be surprised to see Mexico see a really consistent growth in number of cars on the road this decade or growth in number of cars on the road this decade.

Anything else, Ryan, before I move on to management and ownership? No, let's talk management team, because I think on a previous episode or Power Hour, which will have come out before this, you called it one of the best management teams you've looked at in a long time. Yeah. Which is funny because we just looked at Coupang and we said that was probably the best new management team we've seen. Well, you know, you could toss an Airbnb is there as well, but I think if we ever wanted to do a Mount Rushmore top five or rank our best proxy statements we've ever read, or I guess I read it for the show. So the best proxy statements I've read over the years doing the not so deep dives, I think AutoZones may take

this top spot. It was pretty darn flawless. Only flaw was that they use a compensation consultant. So I think we're going to pass though. So since 2005, AutoZone was led by William Rhodes or Bill Rhodes, as people call him. He has been with the company since 1994. In the proxy statement, they brag about, and I guess it's true because I don't think they can lie about this, that executives at AutoZone never leave for other companies. The only time when executives leave them is when they retire. In fact, so that's really, I think, a testament to their culture, a testament to the longstanding management team.

Yes, Ryan, something to add? Yeah, I listened to an interview with Bill Rhodes. The CEO before him actually did leave for Office Depot, I think, which bummer because yeah he missed out on quite the compounding story but bill rhodes who had he did this interview in february he'd been there for 28 years i believe at auto zone was out they have like 83 i guess uh executive management people keys or something yeah yeah and out of the 83, after being there for 28 years, he still only had the 16th longest tenure. Damn. That's pretty good. I mean, yeah, they seem to pay people well, train them well,

and have a strong culture, which you can see come out of the proxy statement. They provide a lot of good benefits to their employees, but they also give them a high standard where they say auto zoners, as they describe them, have to be, they have all that classic stuff, but they actually seem to execute on it. So we talked about people leaving. And in fact, Rhodes is doing that next year. He's retiring. He's going off into the sunset after approximately 20 years at the helm. The vice president of merchandise marketing and supply chain is taking over for him. I don't know much about this guy. Actually, it could be a woman. I don't know. I don't even remember the name. I think it looked like a guy just based on the first name. Okay. The CEO transition is

probably the biggest risk for me we'll talk about later and i think it would be the final test to establish roads uh or maybe the final level if you want to talk about a video game turns as establishing was one of the best ceos probably in modern history maybe ever in my opinion probably if you exclude founders probably the best or one of the best um yeah and if we want to go to the actual stuff here the nuts and bolts they're you know they have standard executive compensation they got bonuses they got stock options but is done so in a way that truly aligns executives and shareholders for one annual bonuses are based on a matrix misspelled that in the notes there of ebit so earnings before interest and taxes uh operating income and then return on invested

capital performance so they just multiply those together to get a number that they pay out And they are not one-foot hurdles like other companies we look at. Here's a quote from the proxy. Quote, as discussed above, the compensation committee used its discretion to adjust annual targets upwards after the first half fiscal year. As such, the revised targets reduced management payout from 297% to 191% of the bonus. So they had a phenomenal year in 2022. I mean, they just crushed it, right?

I think some of that was the pandemic bullwhip. They said, hey, look, this is the easiest operating environment we've ever seen. We don't want to just pay. We set the bonuses. It's tough right now to kind of get a good gauge. And we didn't want to overpay ourselves. I thought that was great. Yeah.

They also pay stock options out on a 10-year time frame. So they're therefore actually long-term as opposed to the three to four-year stuff that people usually do. And then they treat shareholders like partners. I won't read this full quote, but basically, executives have the opportunity to use AutoZone's private aircraft, which is their private jets, but they have to reimburse the company. You never see that anywhere else. Overall, I think there's no current concerns at all with this executive team, the culture

of the business. They think long-term. They think about all their stakeholders, including shareholders, and they return excess cash to shareholders consistently and rationally. The only concern I have is the executive transition, which always brings uncertainty. Talk about ownership too, because I believe all the executives have pretty sizable stakes. Yeah. I mean, executives and directors have 2.6% of the stock, which is sizable for their wealth,

especially because none of them are founders. They hold a lot of it. Rhodes, I know, holds a lot of it. they get those stock options, which again, gives them the ownership over a 10-year period. So it's actually a very long time. It incentivizes them to stay for a long time period. And I believe they give employees a 15% discount. I didn't write this down, but a very big discount if they want to purchase shares for their 401k or something like that. All right. Want to hit earnings, Ryan? What has, I don't know, what does this business look like financially?

well it's been good the other thing i wanted to talk about is uh i think i think it's a like a positive it's a green flag for me if a company's headquartered in the midwest or the south basically not san francisco or new york yeah it's just less i don't know it's more frugal culture it seems when we see that when you see new york when you see basically here's what concerns me when i see new york or san francisco when i see mercenary ceos that are all from recently from consultants or have rotated around a lot of different management teams and then typically not all the time you see them being very um you could allege they're using the balance sheet as their own piggy bank sometimes all right yeah i agree also bill

rhodes minority owner of the memphis grizzlies which i mean they've been kind of a value play over the last decade, I guess. Unfranchised, yeah. Maybe move them to Seattle, but no, that's another topic. Anyway, let's talk earnings. I wanted, since this business has been around for a long time

and it's really, I don't know, it's one of those businesses that you want to look at with a, like you want to zoom out as opposed to any one quarters results. I'm going to give the last decades earnings. So store count has grown by 3% a year over the last decade. Same store sales have grown at three and a half, 4% a year. So revenue as a

whole is like, I think it's 6.8%, I believe. That's the annual growth. Operating margins have expanded slightly. They were around, I think it was like 17, 18% in 2014. And today it's around 18% as well. And it could decline if they go more into commercial, which they'd probably have to have lower margins on. Yeah, I think they basically just have to look at it on whether or not it's

accretive to the operating earnings, which I'm sure if they have a lot of success in commercial, it's going to be accretive. Share count has decreased by more than 6% a year. So basically, if you're looking at this investment, we're going to talk about the

valuation, and I'll foreshadow it here. It's not too crazy. So I think you just basically have to ask yourself, do you think they can do something similar to that this decade? Do you think they can grow store count by 2% to 3% a year, same store sales by 4% a year, and slightly expand operating margins or even keep them flat while reducing share count? If you think they can, then maybe this is an investment for you. But over the last 12 months, they've been growing a little quicker. They're still seeing some inflation that they're passing through to customers. They're seeing a lot of wage inflation for their labor, a little bit of margin pressure from that inflation.

But in general, it's still pretty consistent. Generally, I think they can pass through a lot. I think, honestly, inflation, unless it gets out of hand, is kind of an advantage for them. Yeah, it's probably accurate. I think someone asked on the call, if you get cheaper prices from your vendors, are you going to pass that through? And they're like, well, keep in mind, it's not just supply inflation. We're getting labor inflation, which kind of sounded like a cop-out to say, maybe not.

Yeah. Here's the thing, though, with executives talking about that, it's such a hot-button issue. They can't say that. They're just going to raise prices on everyone explicitly, because then that can turn into a big headline. Yeah, 100%. Yeah.

I guess just for dollar context, they did $3.4 billion in EBIT over the last year, last 12 months. Two and a half, $2.4 billion in free cash flow. There's a lot of CapEx because they build out a lot more stores. Yeah, that's kind of just, I guess, in terms of how much they earn in a year, that's where they're at. They do about $17 billion in revenue. So hopefully, I don't want to bog people down with numbers too much, but I'll leave it at that for earnings. But let's talk about the balance sheet. Pretty solid balance sheet, I thought.

Not a lot of cash. They really just kind of $300 million in cash. I mean, it's a tiny amount, but I think it basically just gives them the flexibility to put money where they might need it. They do have a lot of inventory. So as we mentioned, they kind of hold a lot of inventory at the stores. That number, that inventory number looks like it's growing quickly. A lot of that is just due to the price of the inventory or the cost. So it's basically just growing with inflation.

They do have $10 billion in property and equipment. And kind of going through their 10K, it looks like they own basically half their stores and lease the other half. So I sometimes, I know maybe it's not the most efficient way, but sometimes looking back on success stories like this, it's nice to know there's a little bit of salvage value in the real estate footprint and that they actually own it. So yeah, about half their footprint is owned. And then as for the liabilities, something I thought was interesting, accounts payable is 127% of inventory. So despite being a retailer that turns their

inventory quite slowly, they can still maintain a working capital advantage. I found that pretty impressive. And no small competitor can match that. No, because most vendors or most suppliers aren't going to just take their word for it, or they're not going to believe that some small mom and pop shop is good for it like they'll believe with AutoZone. $7.3 billion in long-term debt. I looked at this weighted average interest rate of 4%. It's pretty much all fixed rate, except for a little bit. So not too crazy. A lot of it matures after 2027.

I thought that's a reasonable rate, especially when they think they're generating returns on capital that they invest north of 15%, like 20%. I mean, if you're borrowing a 4% and investing it and getting that return, it's great use of capital. And the earnings yield too, right?

Yeah, yeah, exactly. And basically $3 billion in EBITDA, so $7 billion in debt, $3 billion in EBITDA, kind of run at two times leverage. The debt really isn't a concern to me at all. And just given the predictability of their returns, I like that they've added some debt to the balance sheet. All right. Valuation.

Let's hit this one quick. Market cap, basically 44.7 billion EV. Enterprise value is going to be slightly higher at about 51.7 billion. I'm using two earnings ratios to value the stock. The first one I'm going to be using is enterprise value to operating income, which is going to show how much in pre-tax income shareholders are earning compared to the size of the entire enterprise. And the second one is going to be price to free cash flow, which is going to evaluate

how much firepower management has to continue repurchasing shares. right now, the EV to operating income is 15.4, and then the price to free cash flow is 17.9. So they're generating a little bit less in cash than they are actually earning. And the working capital stuff can float around a bit on them. I think it's just going to be a little bit more lumpy than their actual earnings. And right now, they're actually in a little bit of a trough. So sometimes they earn, generate a bit more in cash than they do in earnings. I would look at the long-term chart there that will probably have, I'll put a good chart there for the newsletter. Pretty simple though. Below the market average here. I think investors are

concerned about electric vehicles right now, but the stock's not too cheap where people are looking at like a long-term killer to the entire business. Okay. Antical evidence, Ryan, looks like you have some good stuff for us here. Yeah. I went to an auto zone a couple of weeks ago because my girlfriend was having problems with her car. We went in, told them what car she had, what model, what year and what the problem was. They looked up the model, looked up the make and their proprietary catalog told us the specific oil and fluids that we needed. And there are a lot of options and there are a lot of different specifications or specific products you need for different kinds of engines. So having them say that or having them look that up and

provide that info was really helpful for us. Um, and I might not have known, I mean, I wouldn't have known off the top of my head, but I might not have been able to find it online or something like that. Or I maybe would have felt like I was doing something wrong if I didn't go to them. And maybe that's part of just the value proposition is that they give you a sense of security that you're doing the right thing. Um, and, uh, I mean, I guess the other thing, It was a successful experience and it was not cheap necessarily, but her car wasn't working. So it's like, is she just not going to go to work? No, she needs it. It's critical for her to continue basically living her day-to-day life. So you're kind of agnostic to price, assuming that it's not absolutely insane. So I think that's a testament to kind of why they're able to generate the gross margins and operating margins that they can, is because oftentimes these are critical things that people need. They're not sure what they want or what they need. So you can provide that level of service and expertise that people are willing to pay for. 100%. Yeah, I think that sums it up right there. And that gives them that pricing power.

And I think I maybe hit something on my anecdotal evidence is within this market, within the auto repair market, they clearly have a good brand. It's the one that you went through. It's probably the one you thought of first. And they also have that competitive advantage that Ryan mentioned. I mean, I think there's multiple competitive advantages that we may talk about a little bit more in detail in the highlights and lowlights. Anecdotally though, management seems like a big highlight to me. It's a big positive. it's qualitative. You're just kind of listening to what they say and how you feel when listening to them. So again, sometimes people can be pulling your leg and there's liars out there.

But I think when listening to the conference call, they were open, respectful, honest, while also confident about their long-term strategy. Rhodes leaving seems like a big risk, but given how the CFO talked, given how everyone seems to talk to the company, I think he set up a culture to succeed over the long-term. All right. Future growth opportunities, Ryan, unless you have something to add on there, but go ahead. Yeah.

One more thing on that. And I think it's important when we talk about like the moat, we needed that part or we needed that oil that day. We needed the car fixed that day. So ordering something online that might take two days to deliver is just not going to work. And I think that's a testament to maybe their durability and the chance they have to survive versus online threats. I just don't think there's going to be a big online winner here given so much of this is physical in-person encounters. Some of it will be AutoZone, but again, big box and online, Walmart, Target, Amazon, Costco.

they're just never going to be able to compete with the specialty automotive part retailer. This is one of those. I mean, we talk about it within digital space, how dating apps have their own niche. It's one of those where, unless you are, that is your main focus, which is auto repairs. You're not, your value proposition is going to be so much less than an Amazon or a Walmart. Yeah. Well, I don't, I don't know if it applies to Costco because they do have the auto repair

segment, but I think that's why, yeah, I know they have it, but AutoZone continues to succeed because they're the one they can provide that specialty service that people trust more, more than Costco. Oh yeah. I mean, Walmart has, has gone into a tube. Multiple companies have and the specialty retailers have continued to thrive. Yeah. Future growth opportunity for me. I know a long time ago we made this rule that international growth is frowned upon, but you're, there's really kind of,

I'd say two big growth drivers for this business. Rules are meant to be broken, right? Yes. So I'm going to take it here because Bill Rhodes actually said something kind of interesting on the Mexican market on the most recent conference call. So he was asked about the opportunity there and the return profile he sees for those stores. And here's what he said. He said, in Mexico, our returns are better than they are in the US. It's been a very good performing market for us for 25 years now. They actually first launched in the 90s in Mexico, which kind of surprised me. And the most exciting part is as we get further and further in the growth spectrum,

we see more and more growth in front of us in Mexico. They are planning to open a little over 40 stores a year down there. He actually had kind of this funny way of saying that they slowed the store growth in Mexico during COVID. And he said, so they owe us some, they owe us some extras. So they're actually going to probably accelerate that pace, maybe 40 plus stores, um, annually. And it really, given the commentary from Bill Rhodes, it sounds like a perfect market for them to continue investing into. I don't see why they can't replicate much of the success they had in the U S. Yeah. It's given the size of the country, given their current store base,

they could probably open 40 stores there a year for multiple decades. So you combine that with good same-store sales. Yeah. Were you about to ask about mine? Yeah, I was going to say, how about you? Okay. So mine is the commercial opportunity. Again, this is outside of their core, their bread and butter, their original stuff was the DIY.

They're moving more into the commercial because that market is growing quicker. And it's just another way to take advantage of their inventory because people are, at the end of the day, using the same parts. So again, this is a large and growing part of the market. it. There's, again, younger people are less inclined to do DIY. As Ryan mentioned, he is doing some DIY, but generally, when you're doing repairs, there's less people fixing up stuff at home. They have much less market share here. So that can be spent as a positive because they have a long runway to reinvest for growth and take market share, but also they've struggled, I guess, in the past to really get this momentum going. But I think in recent years, it's done well.

So if we look at the segment over the last 12 months, the commercial segment has generated $4.5 billion in revenue compared to $2.15 billion in the same trillion 12-month period of 2018. That is 109% growth over that time period, cumulatively. If we look at consolidated revenue, it is, quote unquote, only up 50% over the last five years. So it's outpacing the overall segment. I would look for that to continue to happen over the next five, 10 years and beyond, because there is still a long runway to take market share if they can succeed. Okay. Highlights and lowlights. Ryan, this has been a compounder, a 300 beggar stock. So clearly there's a lot to like, but let's try to get into the details here.

Yeah. I like Bill Rhodes. I guess that's pretty simple. He seems like he's got this kind of, If you listen to the conference calls, he's got this very Southern, nice guy charisma. It reminds me of, what's his name? Markel. Yeah, actually, you're right. Yeah. I can't remember his name. Tom Gaynor.

Tom Gaynor. It feels very similar. And then in general, people at AutoZone tend to have long tenures. So it feels like people are pretty committed to the business when they start working there. Second one, economies of scale. They get better prices from their vendors than a lot of the local sellers. There's also less time spent on fulfillment, the more DCs they add. So that, I mean, there's less, it helps profitability in terms of time traveled.

The other one is two big tailwinds. The number of cars in the US continues to go up by about 1% each year. And the average age of those cars continues to rise as well, which means they have more people to service. I don't want to go too long, I guess. No, the other thing, I think it'll be immune to online competition for the most part, maybe not in the discretionary categories, but for like the failure and maintenance parts, because customer visits are time sensitive and critical typically.

So it feels like an industry that can weather the onslaught of online sales and it already has. Yeah. And then why would Amazon get into this? Why would an individual online? We looked at carparts.com a while ago. That was a tough business. Didn't look like it was doing well at all. No, I agree. Last one, it's a simple model that generates attractive returns on invested capital,

plain and simple. And they've done it for a long time. And we talked about, it's not just important to have good returns on invested capital. You want to have room to invest capital. And I think there is still that avenue even the us and in uh in mexico low lights for me though there's really only one and it's electric vehicles um i kind of have a hard time getting comfortable with this risk because most of the products autozone sells evs don't need so oil yeah big one yeah i mean it's it would take a long time i think before this really hurts autozone but I just kind of have a hard time because it feels like 30 years out, if we assume that, and the math might be wrong here, let's say 50% of the fleet in the U.S. in 30 years is electric, that's much less demand for AutoZone services. Yeah, let's hope they bring the share count down by another 90% by then. But I agree, that was my low light as well. It's a good thing that the biggest low light is that the business might be in trouble 15 years from now.

but I agree with you. My highlights, you talked management, don't need to talk about again. Look, we'll hit this again. It's the consistent share repurchases. I think one thing that we get frustrated on is when a company is inconsistent with their share repurchases, unless they're explicitly a capital allocation company, because all else equals almost always better to just be consistent with your share buybacks, unless your stock is extremely overvalued or right now we're seeing short-term treasuries at a pretty high interest rate versus what you could probably buy back your stock at. Instead of wasting money on acquisitions, like they may have done in the 90s or getting too aggressive with that, going to money and losing new initiatives instead of

spending $5 billion on some online bullshit, excuse my language, or whatever you'd want to describe the company as, they consistently repurchase stock. They return capital to shareholders while also increasing the per share value for many shareholders. That's just how the math works here. Other highlight, I think the growth in commercial in Mexico may be underrated for the next 10 years. I could see the overall same store sales growth, or I could really see them hitting that same 7% total revenue growth with the, what was it? 3% store growth, 4% same store sales growth. I could see them hitting that unless inflation totally throws things out of whack. I also think the fragmented industry is still an advantage. I think there's a runway there

It's going to be slow, but it's going to be methodical, but it's still there. And then there are competitive advantages that Ryan talked about. I don't think we can, we don't need to talk about that again. You mentioned the low light of electric vehicles. I would also say maybe autonomous vehicles, but that's a strange kind of very unpredictable one. I think that's definitely something that could hurt them if, say, Waymo, Cruise, or something like that goes totally mainstream in the United States that would a hundred percent hurt their

business. Uh, I also think roads leaving the company as a risk. I cannot understate how nervous a CEO transition really makes me, especially one where his track record was so great. Hopefully the culture has permeated and this new person just takes the reins and same as it ever was, but it's always a major risk. I mean, what do we have with, uh, I mean, Buffett never sold, but one of the Coca-Cola CEOs, he really didn't like, and it can really affect the business. It can really throw you off track. You just never know what's going to happen. Say my last one. Oh, I'm worried that operating margins may revert to the downside. They got a nice booster in COVID, but I think you could see wage inflation pressure continue. It's a little

bit unpredictable and it's a weak low light, but we just saw UPS get fat raises with all their unions. And you're definitely competing with that in auto zones somewhat. I mean, they treat their employees well, but I could see them having to raise their wages consistently, which is probably a good thing for their employees, but it's going to hurt their margins. Yeah, I agree. Bull case for me, I'm just going to run through the numbers. So I just kind of did a little bit of some estimates here. If they grow store count by 2%, same store sales by 4%, and maintain 20% EBIT margins for the next five years, and then they buy back 5% of their stock every year, obviously that's dependent on the stock price. It's not always going to be 5%, but it's been

6% historically, so I think it's doable. If all that happens, earnings or EBIT per share is going to grow by 14%. Right now, it's trading in line with, depending on what multiple you use, it's basically trading in line with its 10-year average for earnings multiples. I think it could easily be in the same place in five years. So assuming no change, you've got a 14% CAGR on this business.

I think that's doable. All those numbers seem very doable. Yeah, I have the same one. what's really interesting i think what makes a really strong retail stock uh excuse me our retail stock perform well is you add up a bunch of different factors that you just do very well so for one auto a lot of good retailers do this like starbucks did this home depot list goes on you have bottom line margins that stay stable or grow you have inflation plus industry growth so growth in your industry is outpacing inflation and you gain market share uh and then you can

continue to return capital to shareholders through buybacks. Some utilize buybacks and dividends, but when you add up all four of those things at a reasonable valuation, it's pretty hard to lose money. Bare case though, Ryan, what do you think? The serviceable vehicles start to decline slowly and then probably slowly and then quickly, whether that's because of electric vehicles becoming more common or the autonomy, like you mentioned i think that'll take a while but it's it is kind of a longer term risk and i guess maybe a little bit of sense of safety that i get is that they could potentially retro or change what they're doing a little bit you know maybe they can start supplying things that evs need i

don't know what all that includes they're clearly thinking about it everyone if we know about it They have thought about it for multiple years. Yeah. They also own $10 billion in real estate, essentially, property and equipment. So there's some salvage value there, I guess. I mean, it would be bad for the business. There's no way around it, but it's not. Yeah.

I mean, that is the bear case. Yeah. And we're having trouble coming up with five-year kind of bear case. I think the one that concerns me is if a combination of things create multiple headwinds and your stock price performance is probably flat to probably pretty bad. So I would have margin compression, like I talked about, that could always happen if wages go up a ton, plus low, low inflation, which they do better with higher inflation, especially if inflation is low and wages are rising. I don't think that formula works very well with them.

And then if that happens, I think you also probably get a compression of the earnings multiple. I think you add those up returns are probably pretty bad over the next five years. However, under that scenario, it'd probably be a great buying opportunity in year five. I think today it's not a slime dunk pitch, but as cool as things out, Ryan, more or less interested as we finish the AutoZone episode. Yeah, definitely more interested. I do have a hard time getting comfortable with that EV risk, but this checks every other box for me. It's maybe not the valuation. I mean, our hurdle rate or what we try to achieve is 15%. I just ran through some numbers that all seem realistic and you get 14%. So I'd like to buy it in kind of that scenario you mentioned, which is when maybe they get some margin compression. I think margins can expand a little bit. Maybe they, I don't know, they get some bad news and it sells off or something like that. That's, it's one that'll sit on the watch list and I kind of hope something terrible will happen. Yeah, something.

Yeah, exactly. Not terrible, but you know, terrible for the stock price. Yeah. I'm more interested as well, as everyone can probably tell. I like their competitive advantages. I like that their business is predictable and I like their management team. I would be interested in buying at the right price. I think for a business like this, where you'd be worried about growth a little bit, I would

rather buy at an EV to operating income closer to 10 than 15, but it's not too far away right now. We're at 15.4. So stock sales off 20%. I could see this really lining up. I worry, though, and as we close things out, I think AutoZone, and yes, we might miss another 10-bagger here, but it's one of those where you want to learn the lessons of AutoZone and try to apply it to a younger company that can become that 300-bagger.

What do you think, Ryan? This is one where you learn a lot of lessons and then hopefully find something that fits that pattern recognition. We can find AutoZone of the early 2000s. maybe but every time i say that about a business the business just continues its exceptional performance and then i miss out yeah yeah but monster i worry that people said that about monster 10 years ago oh yeah yeah but when the category is growing and they have room to grow in the category i think you still i think there's still plenty of headway no yeah that's a fair

point i just i worry that the cat's a little bit out of the bag but maybe it's not given the valuation of i don't know if this is ever going to trade at 10 times earnings again i hope it does but i don't know if it will i'd be curious what what the results have been of businesses that have after they've reduced share count by 80% for the first time, what's been the results from there on forward? Because I imagine it's probably a pretty well-known business by that point.

It's probably pretty followed. Right. Returns have probably been good. Yeah. So I don't know if there's any way to find a study that has those numbers. Yeah. Academics use that money.

Let's get a study cooking. But that's going to do it for this episode. next week we're hitting another share cannibal lows the competitor to home depot one of the duopolies there before we get out of here uh if you like the show give us a review on spotify or apple super easy easiest way to help the show and don't forget about the poll and don't forget the poll on spotify anyway it's free like you don't have to pay for spotify so go on to spotify do the poll really helps us i don't know pitch advertisers that are interested in you guys the audience. So also subscribe to the newsletter. It's free. Have the show notes. I'll have all the

charts that we access during this episode. As a disclosure, we are not financial advisors. Anything we say on the show is not formal advice or recommendation. We are channel partners at Arch Capital and clients may hold securities discussed in this podcast. Thank you everyone for tuning in. We'll see you next week. Bye.