Chit Chat Stocks - Why I Own This Boring 100 Bagger Stock (Ticker: ORLY)

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Starting point is 00:00:38 where you can earn a rebate on every contract traded. That's public.com. This is paid for by public investing. Options are not suitable for all investors, carry significant risk. Full disclosures are in the podcast description. Welcome to Chit Chat Stocks. On this show, hosts Ryan Henderson and Brett Schaefer analyze businesses and riff on the world of investing. As a quick reminder, Chit Chat Stocks is a CCM Media Group podcast. Anything discussed on Chit Chat Stocks by Ryan, Brett, or any other podcast guest is not formal advice or recommendation. Now, please enjoy this episode. All right. Welcome in, everyone. This is another episode of Chit Chat Stocks. My name is Brett

Starting point is 00:01:29 Schaefer. And as always, joined by Ryan Henderson, we are continuing our theme and our plan for 2022 of doing a stock research episode about once every month, about once every six weeks per person. And this time, it was Ryan's turn to do a research report. It's a stock he owns. It is, as you'll see from the title here, what we're calling a boring 100-bagger stock. Not very many people follow it. A lot of people probably know what the company is, but Ryan, it is O'Reilly Automotive. So why don't you get into it? What does O'Reilly do?

Starting point is 00:02:05 How does this business work as an automotive parts retailer? Yeah, and just to maybe entice listeners a little bit, I know O'Reilly Automotive is maybe not the sexiest business around, but if you invested $10,000 at its IPO, which was in 1993, a little over 30 years ago, $10,000 today would get you $4.25 million. It's a 425 bagger and one of the best performing stocks the last 30 years. So what does O'Reilly do? I think most people probably recognize the name, especially if you're from the US, the only countries they really operate in are primarily the u.s but also mexico canada and puerto rico um but if you don't know them o'reilly automotive is a specialty retailer for automotive aftermarket parts

Starting point is 00:02:57 equipment accessories stuff like that so that means they sell everything from hard parts like batteries uh chassis parts belts to equipment like filters engine additives oil wiper blades stuff like that, or even stuff like floor mats, seat covers, that's kind of the accessories. They basically anything you need or want for your car after you've taken it off the lot, you can get at an O'Reilly's. The majority of customer transactions are non-discretionary as well. So these are not people that are coming in. You're not really coming in for the floor mats or the little, what do you call them? The little scents that you hang from your rear view mirror it's, those are just the accessories you'll add onto your purchase, but you're usually going in

Starting point is 00:03:49 there. I know O'Reilly doesn't give out the number specifically, but AutoZone, which we've looked at before, and it's their most direct competitor states that 84% of the products they sell are either critical or maintenance parts. So it just kind of goes to show these are people that need something. They don't go in there wanting something. They really need a product. They need help. And typically they don't even know what they need, especially if it's the DIY customer. So that's kind of where O'Reilly comes in and helps out. O'Reilly groups their customers into two buckets. So there's the do-it-yourselfers. Let's say you need some new coolant and you want to refill it yourself. You go into the store, you ask them, ask the store attendant what coolant

Starting point is 00:04:35 you need. And you go and you do it yourself. That's kind of the DIY customer. And then there's the do it for me, which a little bit of confusing terminology here with the do it for me. Basically, this is just professionals. This is the local auto repair shop service provider for your car who needs all these materials as well, but they're buying them in bulk and they're doing it for end customers. So those are the two customers. 53% of the sales come from the individuals or the DIY and 47% comes from the pros business. I'll stop there and let you intervene a little bit, Brett. Yeah. For anyone that's watching on the YouTube or Spotify, you can see the charts that we posted. It separates them out to about 50-50 from DIY versus professional service.

Starting point is 00:05:26 You've looked at, I think, all three of the big auto parts retailers. Does anyone skew more professional versus DIY, like a Home Depot versus a Lowe's, or is it pretty mixed throughout? O'Reilly is by far the largest pros distributor. So AutoZone has kind of lagged there. O'Reilly actually got their start. I'll talk about this in the history in a bit. They started as a distributor for automotive jobbers. So back in the 70s, or sorry, back in the 50s when they first started, they were just distributing tools to people who worked on cars. So that's really their roots. And then they kind of combined into the DIY more in the 70s. And so they have had that business for a while and kind of had some advantages there.

Starting point is 00:06:11 And then it has been the faster growing segment for them as well over the last 10 years. And they expect it to continue to be. So, yeah, they are the leader in the pros business by far. When you say that, it makes me think, you know, maybe this is a stereotype, but I'm pretty confident it's true. is a 20-year-old 40 years ago knew a lot more about cars on average in the United States than a 20-year-old today. Is that part of the thesis? Is that there's going to be more of the professional need as the stereotype of the Gen Z and millennials can't do any handiwork comes to fruition a little bit? That could be the tailwind. I'm not sure what's driving the outsized growth of the pros

Starting point is 00:06:53 business, but maybe that's it. People just don't seem to care to get knowledge of their car, myself included i'm you know i'm not a what do they call it a gearhead you know someone yeah and hey the gearheads are going to o'reilly i actually do know a gearhead friend they like o'reilly instead of autos on don't know why but maybe that's because because of that and i guess anyways it's probably not going to be a headwind that people need to worry about we'll definitely get into industry dynamics later i know people have questions about new cars electric vehicles self-driving cars you know ryan i don't know if he has any thoughts on self-driving cars it's just a big uncertainty in general, but we'll definitely talk about the industry dynamics.

Starting point is 00:07:30 Let's move on to unit economics. This is a big store base. People have probably seen them all around the country. What do their stores look like? How much do they cost to build? What are the unit economics looking like on these operations? Sure. So when we actually look at the O'Reilly stores, they have a lot of standard features across most of their locations that are fairly unique so first off if you've ever driven by one you know the signage is very recognizable that contrasting green o'reilly is on a bright red painted wall i mean you instantly know what it is um so there's there's kind of clear recognition there the other part and they go through this in their 10k is they go through everything they do in their stores all the little

Starting point is 00:08:16 details they've done to kind of optimize their each individual store and then they deploy that prototype on their new builds. They retrofit some existing ones to try and just continuously optimize their stores. And so the other thing, I'll just go through some of the other highlights of a typical O'Reilly location. There is always ample parking. So this might not seem like a huge deal, like, oh, cool, a store has parking. But especially in urban locations, Like more city type living, having a store where there's clearly enough parking spaces where you can go up, you need to bring your car there, it's a huge deal. And so you'll actually notice that sometimes they have more square footage than they need. And even though it seems like maybe they're not optimizing every single square foot of their store, that extra parking, I think, just gives people a little bit of not so much concern.

Starting point is 00:09:18 The other part is you're pulling up your car. Maybe you have to work on it so you don't want cars right next to you. You want plenty of parking space. So it just seems subtle, but it's actually quite helpful. The third thing, they've got some servicing elements to their locations as well. So it's not just an auto parts store. They'll help you with the servicing if that's what's needed. And then on average for the unit economics, a new store costs between $3 to $3.3 million to set up.

Starting point is 00:09:50 So basically call it $3 million. That includes the cost of land acquisition, building construction, fixtures, vehicles, net inventory investment, and computer equipment. Basically everything they need to get that store up and running, $3.3 million, 3 to 3.3. um and they own about 50 of their stores like the they own the land and then the other percent they lease so it's about half and half i might be getting some of those numbers wrong but they use both strategies kind of just dependent on where they think they're going to save the most money and whether or not they want to keep that location and they're sure of it that kind of thing so it's their own analysis on whether or not they want to buy this land versus lease it um

Starting point is 00:10:36 But obviously the cost, the upfront cost, if you're leasing is significantly lower than if you're buying it outright. And you think about, okay, $3 million to set up the new store. On average, and this is a KPI that FinChat tracks, which is our research platform that we use here, an O'Reilly store generates on average $2.6 million in sales annually. that is significantly higher than the typical auto parts store so a lot of that is because they have that pros business these almost serve as like distribution nodes and in a kind of a supply chain network so um they it's they have a big sales lift relative to their the typical store

Starting point is 00:11:22 but that's kind of the unit economics the operating margins come in around 20 percent gross margins, a little over 50%. I'll go through some of the other margin dynamics and why they're so profitable relative to the extra stores, but more or less, they're generating approximately as much in sales as it costs to set up a store in the first year. And for anyone that saw the shared screen there, we've seen, look at the numbers. I'll just read them off here it was 1.8 million 2016 and then it was about 1.8 million in 2018 but today it's 2.6 million from the pandemic to now it's climbed up on that per sales per store did they have they talked about that is that all inflation is that some them taking share what are your thoughts on

Starting point is 00:12:10 why this is happening or have they said anything part of it has certainly been some inflation uh But comp sales have been 13%, 14% for the last three years, so it's been quite high. Actually, it might have been more like 10%, but I think a lot of it has to do with the inflation, but probably some kind of market share wins in the pro market as well. I don't know. A mix of things, but yeah, I would guess a little bit of inflation is baked in there. Okay. Now, we've talked about the customer side of things. It's pretty easy to understand why someone, either professional or do-it-yourself, is going to visit an O'Reilly store. What does their supply chain look like? How are they working as a middleman here, bringing everything to their stores with these complicated parts from, what are there, dozens, maybe even 100 different car brands around the country? Yeah, tons of suppliers. Just tons and tons. I don't have the specific number. I have the number of SKUs, but not the actual brands themselves. Their supply chain is really – so I had heard a lot about this business coming into research. Chuck Ackrey has been a large shareholder. It's been a beautiful business for him, and it's turned out really, really well, as we talked about the returns earlier. And I kind of wanted to know why. What makes it so special? There's another great auto parts

Starting point is 00:13:40 business in AutoZone. Why has O'Reilly had such better performance? And it really is the supply chain. I mean, it's their secret sauce. It's the backbone of this business that drives most of its competitive advantages. They have a reliable and very wide assortment of inventory. So given the time-sensitive nature of a lot of the customer transactions, they need to have access to a number of parts quickly. And thanks to O'Reilly's 30 distribution centers and 385 what they call hub stores, every O'Reilly location has same-day or overnight access to 152,000 SKUs. So every single O'Reilly store, if you need a product, can get it overnight, probably has it in-store for most of the commonly purchased parts or equipment. But if they need to get it,

Starting point is 00:14:35 boom, they can get it there easily. The O'Reilly stores are also equipped with, each one has kind of this proprietary point of sale system that they talk about a lot. And I think people maybe think, oh, great, you have a point of sales terminal. So does every business, but it's integrated with an e-catalog that has all the parts for each car, for each model of the car, so that you can quickly and easily just order it in that system, have it distributed to, or have it come from the distribution center or the, what do they call it? The hub store directly to the O'Reilly location. Boom, you've got it. You can give it to the customer that's right there, or you can deliver it. They do a lot of delivery as well. I've got this quote from a value investors

Starting point is 00:15:17 Club write-up from 2017. I think it's really helpful. It says, O'Reilly is the gold standard of inventory management. Approximately 50% of stores receive intraday deliveries four to eight times per day directly from a dedicated distribution store. Another 35% of stores get access to distribution centers up to twice per day from hub stores. And then 10% of stores get intraday service from a hub, but not directly from a distribution center due to distance constraints. The remaining 5% of stores do not receive intraday deliveries, but receive deliveries five times per week. This system allows O'Reilly to maintain the best coverage of products and parts while maintaining the lowest inventory per store.

Starting point is 00:15:58 So that kind of just goes to show how many deliveries are coming into these O'Reilly locations, how quickly they can fulfill customer orders when they're needed, and just kind of how easy it makes it for the in-store attendance to service customers. They can do it all digitally and they can have it all brought to them quite quickly. A couple other things I'll mention first. Firstcallonline.com. This is the website that pro customers can visit to order any parts they might need. And because O'Reilly has tons of trucks, tons of vehicles,

Starting point is 00:16:33 they have the resources and the money to have all those vehicles, They can deliver them directly to the local pro or even individual customers as, like I said, tons of vehicles. It's very easy for them to add that extra kind of consumer convenience. Two other things, private label brands. I've got a quote here from the 10K. It says our proprietary private label brands, products, I'm sorry, are produced by respected automotive manufacturers, meet or exceed original equipment manufacturer specifications, and consist of house brands and nationally recognized proprietary brands, which we have acquired or developed over time. I believe it accounts for more than 50% of sales come from the proprietary brands, actually, which is higher penetration than I would have thought. But these are a higher margin for them.

Starting point is 00:17:22 They can fill product gaps where they might need. They can, a lot of the time customers are coming in asking for like recommendations. They can easily promote these. And, you know, it's not like they're giving them some crappy product to kind of just because it's their own, that they're offering kind of higher quality or equally high quality products as well. And then the last thing I'll say, they have huge bargaining power with their suppliers. So their accounts payable is 131% of their inventory.

Starting point is 00:17:55 This really helps alleviate the big cashflow lags you typically get with a retailer. And it's like, if you're a supplier to the automotive aftermarket business, O'Reilly, AutoZone, there's going to be your two biggest customers by far. So you're okay. Kind of, you're kind of at their whim. If they want to hold on to the cash a little longer, you kind of have to deal with that. They also, they can write like notes of credit that because they're in such good standing,

Starting point is 00:18:32 I can't remember where I saw this, but if you're a supplier and O'Reilly says they're going to pay you on this day, if that supplier needs to go out and get financing or something like that and use certain collateral, they can say, hey, this is how much I'm getting from O'Reilly in the future. It just kind of helps them, but it allows O'Reilly to kind of hold onto the cash. And then here's one more quote I'll give before I let you kind of butt in here, Brett. It says, net income has converted to free cash flow at 107.3% over the past nearly 14 years. Over that time, O'Reilly has taken accounts payable as a percentage of inventory from 44% to 131% today. Inventory turns over that time have increased from 1.4 times to 1.7 times.

Starting point is 00:19:17 Its proprietary brands penetration has steadily grown and now stands at 50% of its mix, which has helped increase gross margins in that time as well. So just doing a really good job managing their inventory, and that's kind of the beauty behind this business. Okay, so it seems like the key for the predictable power of the earnings is this supply chain advantage. And it's not really the fact that they can put up a store and sell stuff to customers. Obviously, they have a good brand and people trust them, but it's really the stuff that you just talked about, bargaining power with suppliers, delivery, private label brands, firstcallonline.com, and some of the other things. Is there anything you see when researching this that you could envision any scenarios where this changes over the next 10 years? I know the internet hasn't been much of a disruptor for this, just given the nature of the business, but anything out there that have been competitive threats over the years? and any thoughts on them?

Starting point is 00:20:19 No, I mean, the pros market, both the pros and the do-it-yourselfers, these tend to be like businesses where the sooner you can get the products, the better. If they can be delivered same day, that's huge. Because if you're a auto repair shop, you're getting paid based on, you're really compensated for throughput, right?

Starting point is 00:20:40 You want to get people in and out the doors as quickly as you can. So if you can get products delivered to you from an O'Reilly store really quickly, that's much more valuable than ordering something on a car parts website and waiting seven days to get that part you need. So there hasn't been a lot of online disruption. I think it's kind of maxed out around like 10% of this market goes online. So I think a lot of the trends here that O'Reilly has benefited from will continue to persist. they're probably not going to be able to expand their accounts payable as a percentage of inventory that much further without really kind of aggravating suppliers would be my guess and

Starting point is 00:21:24 they've been holding it kind of steady at that 130 figure so i would suspect that kind of stays where it's at all right well let's move on to the industry which is good segue here what are the industry trends, I'm seeing a couple of different things here, especially with the U.S. and Mexico. I know the big holdup for these companies has been the electric vehicle transition as well as the self-driving threat. And that's counterintuitively created the opportunity for the stock because, as we'll talk about later, they've both been, I mean, them and AutoZone, I think the other one as well, which I've never really looked at, have bought back a lot of stock at low valuations and these narratives haven't really come to fruition. So what do you see with

Starting point is 00:22:10 the industry? What attracts you? I know it's an important part when you look at any company you're investing in. Yeah, there's a couple long-term tailwinds that have really benefited this business and AutoZone and even advanced auto parts to some degree, although they've kind of turned into a debt-ridden mess. But with O'Reilly specifically and just automotive aftermarket parts, the cars on the road continues to grow. So the number of cars being driven in America has grown at one, a little over 1% a year on average for the last 30 years. This was probably even higher before that. But the latest 30 year data is around 1% a year. I imagine this is even higher in Mexico as kind of more and more people are hitting sort of that, like they've got really

Starting point is 00:23:00 good demographic trends there. And more and more people are kind of hitting that age where you're purchasing a car. But yeah, there's just more and more cars on the road, which means more and more people potentially going to an O'Reilly automotive store. The second one here, and this one was maybe a little counterintuitive, but the average age of vehicles in America is getting older. So in 2012, the average age of cars on the road was 11 years old, basically. 2022, it stood at 12 years. I know that doesn't sound like a whole lot, but it's turning in the right direction. I kind of thought, okay, cars are lasting longer. That means maybe they're engineered really well and they're not going to need quite as much service. But I was wrong. Most manufacturer warranties end after

Starting point is 00:23:45 seven years. So that sends more cars through the aftermarket shops like O'Reilly, not to mention the older a car gets, the more frequent the maintenance cycles are. Even if it lasts longer, you're going for the oil change, you're going to get new coolant, whatever it is you need, you just got to continue to service it a little bit more. So that's kind of the two big tailwinds for them. And then the second industry trend that I would call out is the market consolidation. So O'Reilly and AutoZone have both been growing share in the do-it-yourself category and the pros market for the last decade, even longer. And now combined account for roughly 40% of the auto parts stores in the United States. Advanced Auto is kind of smaller, and they've actually been

Starting point is 00:24:28 them, along with all the small mom and pop shops, have been ceding share to O'Reilly and AutoZone over the last decade or so. You can see in the chart that Brett's sharing here, O'Reilly's store count has grown at about 4% a year for the last 10 years. AutoZone's has grown at 3%. And then advanced autos is, I think it's up like one, maybe 2% a year. Although a lot of that was one big jump and then it's just kind of declined after that. So the count is actually down from 2014 for advanced auto parts. So they've been, like I said, seeding share more and more to O'Reilly and AutoZone, but those are kind of the two biggest trends, market consolidation. And then still, despite all the talk about electric vehicles and self-driving and even the rise in electric vehicle sales, there continues to be more and more internal combustion engine vehicles on the road.

Starting point is 00:25:29 So it has not hurt the industry tailwinds. Okay. And then do we want to talk about the risks now or do we want to save that for the end of the episode? I mean, we can talk about it now. To me, there's one. There's one big one. Well, two, I guess, if you consider self-driving, but one is it's electric vehicles. I don't really know how to pair this risk because on the one hand, it makes so much sense to me that electric vehicles will continue to take more and more share of overall vehicles on the road.

Starting point is 00:26:02 And eventually, you know, they're just not going to be coming into O'Reilly's because they don't have all the complexity under the hood and the need for all the servicing that O'Reilly has. um but i would have said that over the last five years that electric vehicle sales would go up and internal combustion engine vehicles will decline and it'll hurt o'reilly and that just hasn't been the case so i really don't know what to think about it i think my guess is that electric vehicle adoption will take far longer than people are projecting and we'll probably have a similar number of ICE vehicles on the road in 10 years than what we do today. Okay. And the key risk is that they require less maintenance.

Starting point is 00:26:50 I'd say one thing for anyone that's really skeptical about, like they think it's going to be a huge threat, it's going to kill these businesses. Two things they need to remember. One, these cars still need maintenance. They just need maybe a little bit less. and then second remember that the market share gains aren't on cars on the road specifically those are the numbers that get cited usually it's percentage of new cars sold so i think the headwinds really not going to show up materially until we hit a hundred percent of new cars sold

Starting point is 00:27:21 which are still way way less than that and that could be in 10 years from now i think it's kind of the rough projections people lay out but even when that's the case the that won't be a hundred percent of the cars on the road. So there will still be ICE vehicles for probably, and what did you say the cycle was, about 15 years at this point? So it's a long-term threat, but by that point, Ryan, you're going to be hopefully heading into retirement. They'll pay you quite a few. I don't know if they pay a dividend here, but since we're about to get into this capital allocation strategy, well, they'll have plenty of cash to buy back more stuff. Yeah, they do not pay a dividend. Let's get into the capital allocation strategy. This is probably what kind of excited me the most.

Starting point is 00:27:59 O'Reilly runs a very consistent capital allocation strategy and it's done a phenomenal job at sticking with it and not kind of wavering in its strategy, despite different management coming in and kind of new CEOs in kind of the head seat and not, they've all just stuck to the same exact strategy more or less. So the first priority for the company is investing back into the business where it sees a need. It does a very good job of this. It doesn't really seem to cost them that much. These investments come through the income statement for the most part. This is new technology, new software. There's CapEx involved with new stores, new distribution centers. I would consider that investments into the business. But then O'Reilly also acquires

Starting point is 00:28:43 competitors when the opportunity makes sense. I had heard all about the buyback and that had me excited, but the acquisitions, this makes a ton of sense to me. So there are a couple of reasons they're able to acquire competitors and why they choose to acquire competitors. For starters, it allows them to add new locations in bulk at a fraction of what it might cost to do so one by one. And they're buying brands that are already well-known in areas where they're trying to expand. So one of the ones they just did, they just bought Group Del Vasto, which has 23 stores in Canada. They didn't previously operate in Canada. If they just went in there with the O'Reilly brand, they might not be exactly known. They'll kind of rebanner those companies

Starting point is 00:29:33 and change them to O'Reilly over time, but they're going to do it slowly. Those stores already have a consistent customer base. So it just helps them expand into new markets. But the other part here is they can acquire them at what maybe don't seem like attractive multiples on a trailing basis, but there's an instant sales lift in having them as an O'Reilly store. So they've actually been doing this for a long time, these acquisitions. I would say they've been doing pretty much one acquisition every two to three years where they add anywhere from like 20 stores to 100 or 200 stores in basically one big gulp. And like I said earlier, they generate about $2.6 million in sales per store on an annual basis. The average store

Starting point is 00:30:21 makes around $1.5 million in sales a year. So when they instantly become a part of the O'Reilly network, a couple of things happen. First of all, you become a node in the pros distribution network. So instantly you're selling into pros and you can get tools, parts quickly from the local distribution center or a hub store, and you can automatically deliver them to the pros. Boom, that's a lift in sales. The second one, people sometimes search specifically for O'Reilly. You know, some people will look for auto parts stores online or on maps or whatever. Some people will just look up O'Reilly because there's the name recognition there with customers. Then third, they have shared resources and systems.

Starting point is 00:31:09 So it doesn't cost, their per store profitability is going to be higher because they don't have to do all of this on a store by store basis. A lot of it's controlled at the corporate level. So they're just sharing a lot of those backend costs, which spread across all its store bases, makes it a much more profitable operation. So you're getting way more sales. You're getting way more profits on a per store basis, which makes the multiples that much more attractive when O'Reilly's buying these ones in bulk. So that's kind of the second thing.

Starting point is 00:31:39 The other thing I'll mention on the acquisitions, when they make a big acquisition, you'll sometimes see margins coming down a bit just because they're still converting those stores to O'Reilly stores. So it's a little bit margin dilutive, but over time it kind of disappears. The last element to their capital allocation strategy is their buyback program. They are extremely consistent about buying back stock and they've pretty much dedicated, I think more than a hundred percent of their free cashflow to stock buybacks over the last decade. So you can see their breadth share in his chart. The share count has been more or less cut in half over the last decade.

Starting point is 00:32:19 It's declined at a little under 6% annually, which has just been like gasoline to the fire when it comes to earnings per share growth. Maybe you can pull this up, Brett. Net income growth versus earnings per share growth. Yeah, we'll do. Yeah, just keep talking there. Or maybe I can talk about the buybacks here. What I think is interesting and why I like to use linear charts, or excuse me, the line chart,

Starting point is 00:32:47 which I like to talk about back and forth on, on FinChat.io, is that you can see the rate of change and whether it's been, how would I say it? Progressing. Yeah, progressing, or if they pause, or if it's, but this one's extremely linear. We can see that it's permanently had a fairly cheap multiple. It's never gotten too expensive.

Starting point is 00:33:08 And let me try to get to this per share stuff here. Here, one sec. You can have it loaded up. Earnings per share. Let's do both on a line. how about that there so net income's grown at a 12.8 percent rate since 2014 and earnings per share ryan has grown at a 20 percent rate 19.8 so you're right that is that gap essentially that buyback and once you compound that over time it can be very it can be much more attractive

Starting point is 00:33:35 obviously to have 20 earnings per share growth versus that 12.8 so yeah not not bad there and what I like is that they're consistent regardless of the valuation. We'll get into the earnings multiple, I think, in maybe two more sections. And what I noticed when going through your notes is that this is probably at the launch of the Model 3, maybe, when EVs kind of had their first push back in 2017. Valuation kind of came in. Earnings multiple is down to about, what would I say? It was like 10 lower than it usually is. And they still bought back stock. and that share count came down even quicker, that can be very helpful, I guess, psychologically

Starting point is 00:34:16 as an investor where you know if the stock's getting cheap, if it's maybe underperforming, if you're in a 30% drawdown, you know that management, as long as the business is fine, is going to take advantage of it. Yeah, absolutely. I guess the last thing I'll just say on the capital allocation is they'll use a little bit of debt to fund the business.

Starting point is 00:34:37 it's usually not much um the current debt to ebita ratio is 1.95 and they said on the last conference call that they actually target 2.5 and the interest rate is a little over four percent so i don't know why um it'll be more expensive to refinance right now so maybe they're waiting yeah they sometimes like are willing to take i don't know i must be missing something because They're like, oh, we're willing to take some out of a revolving credit facility to add new stores and stuff like that. But that's the highest rate debt that they have because it's variable rate. And it's like, what is it? SOFR plus 1% or something like that.

Starting point is 00:35:20 They could lock in like 7%, 6% on a 20, 35 or 20, maybe. I mean, that might be too low. But given how consistently profitable they are, they could get as cheap as any company out there. Yeah, all their fixed rate debt is super low. And the majority is fixed rate, like the vast majority, I think probably 70% or 80% is fixed rate debt that they've issued over the last kind of five years, and it's quite low. So anyway, they like to run with a little bit of debt, not too much. They're fairly conservative. They don't hold a lot of cash on the balance sheet, so probably because they generate such consistent cash flow, they don't need to.

Starting point is 00:35:59 But let's shift gears here and talk a little bit about the corporate history. Um, I'll just kind of, I'm supposed to leave the question to you, but I think I'll just lead into the next one here. Yeah. Talk about this. And this is also the people and the culture, which for any new listeners, it's something that's important to us. I know it's hard to quantify on a podcast where you just say, I feel good about them,

Starting point is 00:36:22 but we're going to get Ryan's thoughts about their culture and the people, uh, and this executive team. Finchat.io is the complete stock research platform for fundamental investors. they have all the standard financial data on more than 100,000 stocks globally. And beyond that, they have company-specific segment and KPI data on more than 1,500 stocks. So to give some examples here, you want to see Netflix's average revenue per member over the last 10 years? They've got it. You like to track YouTube's advertising revenue? They've got that too. If you want to see Celsius's revenue that comes from Costco, how much of their revenue

Starting point is 00:36:58 comes from Costco. They also have that. So the breadth of FinChat segment and KPI data truly is one of a kind. I use FinChat every day to track and manage all my investments. I also use it to discover new investments. And if you want to get 15% off any paid plan, go to FinChat.io slash chitchat. That's FinChat.io slash chitchat to get 15% off any paid plan. The link will also be in our show notes. Earlier in the show, you heard us talk about the investing platform public.com that's where you can trade options with no commissions or per contract fees and you get a rebate of up to 18 cents per contract nerd wallet recently gave public five out of five stars for options trading if you want to see why go to public.com and start

Starting point is 00:37:43 getting a rebate of up to 18 cents per contract traded this is paid for by public investing options are not suitable for all investors and carry significant risk full disclosures are in the podcast description us members only yeah let's start with the history uh so o'reilly auto parts was originally founded in 1957 in springfield missouri uh they were founded by a father and son combo and charles and chubb o'reilly which kind of just i don't know funny name chubb's the nickname for the son but anyway uh they had been running a together they'd been running a different auto parts store and then something happened i can't remember i think they were relocating or whatever And so Charles and Chubb decided we're going to spin our own O'Reilly Auto Parts where we distribute auto parts to car automotive jobbers.

Starting point is 00:38:32 And the concept was pretty successful, it looks like, from early on. If you go to the O'Reilly history page, there's some funny photos. I don't know why. I just always love looking at big national chains in the early days. O'Reilly, definitely some good photos in there. And the expansion was really not that quick. It was pretty gradual. And then it kind of picked up steam in the 60s and 70s.

Starting point is 00:38:58 So their second store came in 1965, so eight years after their first store. And it wasn't until 1975 that they actually needed to acquire a distribution center and corporate office and kind of professionalize. And then they reached 100 stores by 1989, which was 32 years after their original founding. they reached 100 stores. And in 1993, they went public. Then in 1998, O'Reilly had probably its most transformative moment when it acquired high-low auto supply. High-low had roughly the same amount of stores and gave O'Reilly an expansion into the Texas and Louisiana markets. And it basically doubled the size of the business overnight. We've actually seen this before. I

Starting point is 00:39:41 think it was, it might've been Adobe that did it. But companies where it's maybe an early concept, they're fairly popular, a hundred stores, that kind of thing. They go public and then they use that stock or that the fact that they have access to public market capital to acquire a competitor or some sort of a peer and it doubles the size of the business or something like that. So that was the case for O'Reilly. And since that point, it has basically been more of the same playbook. Consistent store expansions where it identifies a need for one and then strategic acquisitions when the opportunity is there. And then today, they are on just their fourth CEO, which I find pretty incredible. It's been operating for nearly 70 years and this is just their fourth CEO and it's Brad Beckham. It's always a good sign. I think that's something you can't just say, well, if it was five or six, that's not good. But it's generally, if you don't have a revolving door in the executive suite and a long history of that, that can be a great sign, Costco, stuff like that, of a high-quality business.

Starting point is 00:40:53 Yeah, 100%. I recommend looking through the 10 years of all the executives because they've been around. Um, so Brad Beckham actually joined O'Reilly as a store parts specialist in 1996. So he was literally sweeping the floors of an O'Reilly automotive store. Um, and that's just worked his way up. He worked his way up to store manager and then up and up. And finally he was promoted to CEO. I want to say in the last year.

Starting point is 00:41:20 Um, and obviously it's, it's very qualitative kind of, uh, trying to determine whether or not a CEO is good or not. But I do like what I've heard from him. And here are some of the quotes from him at the 2022 analyst day. He says, at the heart of our culture is promote from within. Somebody like me that didn't even go to college has been very fortunate to grow up with a company that promoted virtually 100% from within, especially in store operations. This isn't a business that somebody can just walk into. You have to have a good understanding of what makes those shops tick, what really happens on the counter every day.

Starting point is 00:41:54 Our business is a consulted visit. When you see our stores, we have several thousand SKUs that are out on the front floor, but the far majority of the parts are in the back room, so to speak, behind that counter. And so even when you move on

Starting point is 00:42:07 to the next level of leadership here, we have 13 divisions in the United States and every one of those division vice presidents ran an O'Reilly store. They started out in those stores, every single one of them. So kind of long-winded rant there, but it's basically just to say,

Starting point is 00:42:22 you can't just have some merchant CEO come in here and have like, oh, I've run stores before. I'm going to hop in. This is a business where it pays to know the customer. It pays to have been in the stores and experienced working with the employees, what they're looking for, what kind of drives them, what brings them in on a daily basis, what are the customers experiencing. And I like the term here that he used. our business is a consulted visit. Most people come in and they don't know what they need. Like they're like, something's wrong with my car. I've got no clue. Will you diagnose it for me? And so there is that, that level of care there. And it's also not the kind of spot where you're

Starting point is 00:43:06 going to cheap out. Like, and I'm going to say, ah, $40 instead of $30. I think I'll just operate without my car so it's just they do a good job of knowing who they are and brad beckham has seemed to have a really good grasp after uh working at the company for 30 years on really what makes the business tick i did not really have to uh sorry to cut in here don't really have to worry about what we always worry about or worry about with a lot of companies we look at is the mckinsey mind virus uh not the single they're not the consultant mind virus that we've seen ruin a lot of companies or at least we think has ruined a lot of companies yeah they i mean yeah these guys have been around for a while they all have a good understanding of

Starting point is 00:43:55 you know what's important to the business and a lot of them like he said worked at stores um So I didn't spend too much time on the proxy statement. I checked it just to make sure the compensation wasn't crazy. It was not. It was very reasonable. Like most, you've got your base salary, cash bonus, and long-term share-based incentives. The CEO, this was before Brad Beckham became CEO. So it was a different guy at this point. He got paid $5 million in total comp, but all other executives were between $1 million, $3 million. There was nothing too crazy. Um, and the targets were all pretty reasonable. Um, the there's variability in kind of operating income or free cashflow from year to year. So sometimes the nominal target will change, but

Starting point is 00:44:44 basically the two big ones that account for most of the share long-term share based incentives were comp sales growth and operating income growth. And their target for last year was 5% comp sales. So I think that's a solid target. It's not like they're being paid to not grow on a store-by-store basis. And then also, I think it keeps the focus on the stores. It keeps the focus on making sure the stores themselves are growing by having that comp store sales figure and not kind of, I don't know, I don't know what else you'd focus on, but not like massaging the financials to make everything look good. you know they seem okay yeah the the comp sales i like and the operating income growth i like i think comp sales is good usually for a company like this where but also maybe like a margin target a profit margin target because you have that combination of comp sales while we don't want to drive comp sales just by selling stuff for cheap and driving a ton of volume and making less money the comp sales plus margin is nice but i mean it's much better than than a lot of

Starting point is 00:45:47 other companies out there. Why don't we talk as we move into the closing segments here, competitive advantages and valuation? As we wrap things up on why you own the stock, as a disclosure, I think we talked maybe about it at the beginning. Ryan does have a position here. I think we put it in the title as well. Why do you own it and what's the valuation competitive advantages look like? Yeah. A couple of weeks ago, you asked me this question around what was the competitive advantage of an O'Reilly. And there really wasn't one obvious one that you see with like a visa or something where it's like, okay, the network effect obviously powers this business. It feels

Starting point is 00:46:25 more like they've got a hundred little advantages that they've developed over 70 years of serving both customer groups that allow them to be far more profitable than their competitors. So I'll go through some of the ones that came to mind. First one is the robust digital catalog. This really does make it easier for the in-store personnel to service customers. They can go out, they can take a picture of the car, they can get whatever the – I think there's – in your car door, there's like a little barcode on what kind of model it is, all that stuff. They can get the part that's needed. They can check it out. They can diagnose the issue.

Starting point is 00:47:00 So that's one. The streamlined supply chain, like I said, that's the backbone of this business. the ability to deliver 152,000 SKUs to any of their stores for the most part, same day or overnight, it makes it really easy to get customers what they need. The distribution capabilities, so being able to deliver to them. Most stores do not have, like your average mom and pop shop, they're not going to have a bunch of delivery vehicles that can go out and deliver auto parts to customers. So that's another advantage. Name recognition from customers. I think this helps when you open a new store, have that just immediate sales lift relative

Starting point is 00:47:38 to a mom and pop. National marketing, this is another big one. They get to spend less on marketing as a percentage of revenue while still spending more nominally because it's spread across that massive store base. Fifth one, or maybe this is sixth, shared backend systems, accounting, HR, billing, invoices, all that stuff. You don't really have to worry about it that much at the per store level because you're basically just inputting data. You're not like setting it up from day one and starting all this

Starting point is 00:48:07 stuff from scratch. You're just repeating the same playbook from the last store. The last two I'll mention here, private label brands, they can offer products where they see a gap or they can promote their own products, which might have higher margins. And then bargaining power with suppliers. They are probably one of, if not the largest customer for most of their suppliers. So they're able to get bigger discounts on a per unit basis than peers. They can either pass those cost savings through, or they can take the higher margins, whichever it is. Those are just a few, but I think together they add up and create just a better customer experience for the most part and a more profitable business as well.

Starting point is 00:48:49 All right. Valuation. What are your thoughts? I'll share a screen here for anyone on YouTube can kind of check out that. What are your one EV to EBIT? But yeah, what do you think? Is this stock cheap is it expensive i know you didn't buy it yesterday so it's a little different but let's go through that as we wrap things up no i don't know if it's cheap or expensive i guess the they currently trade an enterprise value to ebit multiple of 21 times which is above their historical average uh brett mentioned that they kind of got pretty cheap throughout 2016 2017 timeframe. It was above their historical average, but 21 times I think is reasonable. And I guess I'll just try to keep the math on this simple. The tailwinds that have helped the

Starting point is 00:49:37 business thus far, I think they will continue at least for a while. Like Brett mentioned, it would take 100%, maybe 50% of new vehicles produced to be electric vehicles before the serviceable customers really started declining for O'Reilly. And I think that's a long ways away. So I would assume 4% to 5% comp store sales growth, which is well in line with historical average. I think it's actually a little lower than historical average. Then another 2% to 3%, maybe higher from new store contributions.

Starting point is 00:50:13 So new stores that they're adding each year, they are expanding internationally, and they've been talking a lot about Mexico and investing there. So maybe store count grows a little faster. If they can really accelerate the revenue growth for Mexico and the store base there, I think that could be kind of a surprise to the upside here. But additionally, I would suspect that margins continue to grow from all those same sort of cost advantages that we've talked about, that the costs kind of come down as the number of store locations grows. So we're looking at probably 8% revenue growth per year, 10% to 12% earnings growth with the buyback around 15% earnings per share growth. I guess you don't really have to do that much difficult math here. I don't think the multiple will change that much.

Starting point is 00:51:02 And if it does, they'll buy back more stock. If the multiple stays the same, earnings per share grows 15% a year, you're going to get a 15% return. So I think it makes sense from here, and I think it's a fairly predictable business. So I'm not screaming to buy it. I have a hard time kind of dealing with that EV risk long-term, but I'm comfortable having this be one of my core positions. And if it got cheap enough, I'd feel very comfortable adding to it. Yeah, it seems like definitely a high-quality one to buy in a potential recession. I'm sure the EV-to-EV at multiple, while not maybe trailing as cheap during the GFC because there might have been a tough period for comp sales as people delay putting in parts.

Starting point is 00:51:49 On a forward-looking basis, yeah, it could be a cheap one like that. But let's wrap things up with risks and why you would sell, say, three years from now. I know you have your criteria of holding for three years minimum from the starting purchase. Why would you sell O'Reilly? What are you watching for for reasons to sell? yeah it's tough uh well i'm not gonna sell for three years i'm committed to that little pledge i made to myself um the biggest risk is kind of the rise of electric vehicles you know if you

Starting point is 00:52:24 if i started to see figures that like whatever 60 of vehicles produced this year were electric vehicles i would be concerned but i think we're quite a ways away from that still um despite all the progress that's been made so far. So I'm comfortable with that. That really is kind of the most alarming risk. The rest of it, I'm not too worried about. And I invest a lot in stuff where I think I have like some original thesis and I'm like being creative and maybe it's undiscovered, stuff like that.

Starting point is 00:52:57 I take a little bit of solace in knowing that this is an investment that has worked out really well for a lot of people for a long time. And it's a blueprint that has, or a formula that's worked well for O'Reilly. Like they know what they're doing. When they open a new store, they know exactly how to get it to the level and the operating efficiency that they want. They've done it 6,000 times. I mean, I think they're going to continue to do so.

Starting point is 00:53:23 And so, I don't know, it makes me a little comfortable that I can hold this for a while and not get shaken out of something. All right, beautiful. That's a great way to wrap things up. Let's hit the disclosure actually first. Let me say what our little rough schedule is. We've got some fun interviews, potentially something on nuclear energy,

Starting point is 00:53:43 investing in nuclear energy, potentially in some Latin American stocks. I haven't chosen my new research episode, but I think it might be in a little defense contractor that has done extremely well and super exciting, although I haven't firmly decided on that yet. And we're doing Peter Lynch. within the next month.

Starting point is 00:54:04 So keep your eyes peeled on that, or I guess the downloads peeled on your little podcast feed. But Ryan, anything else as we close things out? I think contingent on any changes being made in the future, I'm going to do Ulta. I got some anecdotal evidence this week. I think it's going to be a, that might be a buyback machine. The next O'Reilly question mark?

Starting point is 00:54:29 That could be our... although O'Reilly's not very SEO friendly and that's why it's been a hundred bagger because no one really follows it they'd rather look at

Starting point is 00:54:36 Costco and video and all that good stuff which I've done well but you know the stock has stayed permanently cheap for a reason because not that

Starting point is 00:54:44 many investors are interested in it and it is an unsexy one but yeah that could be fun also definitely fun a lot of people have recommended us

Starting point is 00:54:50 looking at that and we've done it briefly on a power hour but getting a full research episode answering all that full questions could be fun so we got a lot of fun stuff

Starting point is 00:54:57 coming as always we're going to do a power hour every week. Those are our fun live episodes. Join us live in the comments there. Subscribe on YouTube, Spotify, or Apple Podcasts. Disclosure, we are not financial advisors. Anything we say on the show is not formal advice or recommendation. Ryan, I, or any podcast guest may hold securities discussed in this podcast, may have held them in the past, and may buy, sell, or hold them in the future. Thank you everyone for tuning in. I hope you learned a lot. I did as well. We'll see you next time real canadian superstore has everything you need this back to school season save on

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Chit Chat Stocks - Why I Own This Boring 100 Bagger Stock (Ticker: ORLY)

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