Automotive Replacement & Accessories Continues to be a Winning Theme
Submitted By Trader Mark
As the American consumer weakens, and in my estimation - shall remain weak for an extended duration - we put the spotlight on the Automotive Replacement & Accessories sector a few months back [Jan 15, 2009: Thesis - Automotive Replacement and Accessories] Since then, all four names we mentioned in the piece, even the major laggard of the group have surged despite a very bad January and February for the market.
Autozone (AZO)
 O'Reilly Automotive (ORLY)
 Advanced Auto Parts (AAP)
 ...even lowly Pep Boys (PBY)
 Worst quarter since the 1930s? Not in some quarters. I'm posting some more stories from the press now that the mainstream investing media is catching on... keep in the mind, these are counter cyclical plays and if you are of mind the economy will be recovering "soon" or we'll be back to normal "by the 2nd half of 2009" or even early 2010, these stocks will fall out of favor. I am not of that mind and believe a consumer facing ever higher unemployment, wage pressure, and ever higher living costs will continue to focus on keeping up what they have instead of flipping into a new car every 3-4 years like the "good ole days". Which leads to me to another thesis which I'll present in the coming days.
One other "risk" might be the government's push to do everything in their power to make you buy new cars - there is now a lot of talk about mimicking the German plan to subsidize new cars in return for turning in clunkers [Mar 3, 2009: German Auto Sales Boom to 10 Year High Due to Government Scrap Bonus] I think that will help new car makers on the margin, but as a whole the U.S. savings rate has been nowhere near the Germans the past decade so without the house ATM (which the government is also trying to reignite) new car sales will be depressed for quite a while. Remember, Americans were resorting to 6, 7 and indeed even 8 year car loans (mini mortgages) even WITH the house ATM at the peak on insanity a few years back. [Feb 13, 2008: Car Loans Being Stretched to 7 Years] [September 2007: Is a 10 Year Car Mortgage Far Off?]
The first piece is from Investors Business Daily and is specific to our holding in O'Reilly Automotive - again with this name there is more uncertainty with the near term due to a large integration but some very nice long term synergies. Along with Autozone they have top notch management.
- Americans have cut back sharply on new auto purchases. But that only means they're driving their old cars longer. And that translates into more sales of batteries, fuel pumps and other replacement parts sold by O'Reilly Automotive.
- O'Reilly (NasdaqGS:ORLY) now trails only AutoZone (NYSE:AZO) and Advance Auto Parts (NYSE:AAP) as a retail source of aftermarket parts. In the wake of its purchase of CSK Auto last year, O'Reilly now has more than 3,200 stores in 38 states. Strong in the Midwest and Southeast, it now has presence in the West Coast, too. It is also creeping northward along the Atlantic seaboard.
- In the fourth quarter of 2008, O'Reilly had sales of $1.1 billion. That's 85% better than the year before, mostly the result of the added business from CSK, which operates under the names of Checker Auto Parts, Schuck's Auto Supply, Kragen Auto Parts and Murray's Discount Auto Stores.
- But O'Reilly also managed to grow sales at its existing stores by 6%, a strong showing for any retailer in the current slump. And it has been able to move in on acquired stores and very quickly improve their performance. Sales at CSK stores were actually up for the first time since the third quarter of 2005. Earnings, affected by several charges, slipped somewhat. But CEO Greg Henslee expects earnings to grow to $1.83 to $1.87 a share this year, up from $1.65 last year.
- The O'Reilly story is one of superb execution, abetted by favorable macro trends. As consumers shun new car showrooms, they must keep up their old vehicles. The average car is now almost 10 years old, notes Tony Cristello, an analyst with BB&T Capital Markets. "As that age climbs, you start to see a higher failure rate of critical parts," said Cristello.
- And surveys of auto owners by Stifel Nicolaus show that more drivers are now working on their own cars. In the spring of 2007, reports Stifel Nicolaus analyst David Schick, 5% to 6% of surveyed motorists expressed an intention to work on their own cars. But this year, 9% expect to get their hands dirty.
- O'Reilly benefits from its sales of parts to both individuals and garages, says William Blair analyst Jack Murphy. This strategy is helping O'Reilly gain market share. Especially now, adds Cristello. In 2008, 900 auto dealerships closed. This year, he expects 2,000 to 4,000 to shutter. This drives business to the independent service stations that are often O'Reilly customers. "If I can't go to a dealer, I will go to an independent," explained Cristello. And owners of older cars are already more likely to take their cars to independent garages than to dealers. [Oct 1, 2008: Reuters - 1 in 5 Auto Dealers Could Go Under in 2009]
- One more developing trend is helping O'Reilly. As oil prices soared in 2007 and much of last year, motorists cut back on mileage. In December, though, there were signs that motorists, likely encouraged by lower fuel prices, were returning to the road. Old cars driven more miles play right into the hands of part sellers like O'Reilly.
- O'Reilly is also maximizing their impact with deft execution. A prime example is the way O'Reilly has improved performance at the acquired CSK stores. "They're applying their seasoned knowledge of the business to a chain that wasn't spitting out optimal results," said Schick.
- Many of the CSK stores, says Cristello, were "underinventoried and had a poor mix of inventory." Because of constraints on working capital, these outlets often didn't have the parts customers wanted. Some stocked items like safes and blenders -- not top priorities for the desperate motorist whose water pump just bought the farm. CSK also lacked a private-label, entry-level product line, Cristello adds. O'Reilly puts heavy emphasis on having the right parts. "If I have that part any time a customer calls, I'll become the first store the customer will call," Cristello said.
- And O'Reilly tries to understand the markets it serves. "They have a good understanding of what parts are needed in a particular market," said Schick. To gain that understanding, O'Reilly may study vehicle registration data in the vicinity of a specific store site. That way it can determine the mix of cars and SUVs, or the popularity of Hondas vs. Chevys.
- O'Reilly also moved to lower prices at acquired stores. "CSK was simply not competitively priced," CEO Henslee told analysts on a Feb. 19 conference call. Price cuts vary by store, but overall were 2% to 4%.
- By mid-February, O'Reilly had worked its magic on 96 of the CSK stores. Henslee expects 185 store conversions will be done by May's end. Results improve almost at once, says Henslee. Old stores that had been ringing up shrinking sales volumes turn positive after three or four weeks. By their 14th post-conversion week, the stores were showing year-over-year sales gains of 16.4%. In their 15th week, they were showing gains of 17.3%. (wow)
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More of a general story here; what is interesting here is the anecdotal story of those who can afford new cars not buying them - AP: Consumers Clutch Cars Longer, Choking March Sales
- She wants a new car, but Pamela Davies is still driving the very first one she purchased. Even with 81,000 miles on her 2001 Toyota RAV4, the stay-at-home mother of two young children isn't ready to give it up. Her husband's 1999 Corolla, with 136,000 miles on it, is fine for now, too.
- Davies said her family could afford a new car, but the two they have are fully paid for. She and her husband would rather not take on a monthly car payment as they save for college and retirement. The recession has forced the Davies and many other Americans to rethink their spending habits. One result: They're making their old cars last longer.
- Consumers are starting to see vehicles as long-term investments, said Trevor Traina, founder and chairman of the car ownership Web site DriverSide.com. Automakers for the most part have stopped offering leases, which allowed people to drive a new vehicle for $200 or $300 a month and repeat the cycle every few years. People are taking better care of their old wheels instead.
- Car owners like Davies are one reason auto parts stores such as AutoZone Inc., Advance Auto Parts Inc. and O'Reilly Automotive Inc. have seen rising sales. They're also one reason the new car market is in the tank. "The desire to own a car for two to three years is dead," Traina said. "It's like people have woken up from some kind of consumer dream of flipping a car the way you change clothes."
- Deutsche Bank Securities analyst Rod Lache estimates that U.S. auto sales for March will decline 43 percent from a year ago to a seasonally adjusted annual sales rate of 8.6 million vehicles. Wachovia Capital Markets analyst Richard Kwas forecast a March annualized rate of 9 million vehicles, just under February's rate of 9.1 million. J.D. Power is predicting an annualized rate of 9.2 million for March. That would be lowest figure since Ward's Automotive Group began tracking monthly sales data in 1980. There were 16.1 million vehicles sold in 2007.
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General piece from Morningstar: Automotive Parts Retailers a Bright Spot
- After a tough 2008, the aftermarket parts industry is set to benefit from pent-up demand and recent declines in new car sales. Since demand for replacement parts and maintenance tools stems primarily from necessity, rather than discretionary purchases, we think the industry's long-term growth prospects are bright. Additionally, the industry remains highly fragmented, with national retailers representing less than 20% of the entire market. We believe this leaves national retailers plenty of opportunities to capture market share from independent retailers.
- In our view, AutoZone (NYSE:AZO), Advance Auto Parts (NYSE:AAP), and O'Reilly Automotive (NasdaqGS:ORLY) are in the best position to benefit from these favorable industry dynamics, thanks to scale advantages and superior distribution capabilities.
- Although these companies generate the majority of their sales from the automotive parts retail business, they have been expanding aggressively into the faster-growing commercial market, which sells automotive parts to professional installers and repair garages. We believe these national retailers could leverage their expansive store network by adding the commercial program to existing stores, which should help boost returns on invested capital. Furthermore, demand in the professional segment is more resilient to economic swings as it is less reliant on consumer spending patterns. The commercial business stands to gain from favorable tail winds as independent garages may benefit from incremental business due to the closures of automotive dealerships.
This is a good article of substantial length - like a mini sector research report, you can follow the Morningstar link for the rest of the piece if it is a topic of interest.
[Mar 3, 2009: Autozone (AZO) Surges 10% on Weakening Consumers Sticking to Fixing What they Have]
Long O'Reilly Automotive in fund; no personal position
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