For several quarters, AutoZone Inc. investors have been asked to be patient while management implemented a series of initiatives to fuel more meaningful top-line growth. Part of the company's strategy includes another effort at accelerating its commercial sales with a better mix of hard parts and a renewed focus on building a better commercial sales force.
AutoZone's fiscal fourth quarter results might have been the first indication that management's renewed focus finally is gaining some traction. Even with the loss of the Midas supply contract (which we estimate impacted the fourth quarter by $10 million to $15 million and probably was worth $50 million annually), commercial sales ticked positive for the first time in three years. While this certainly was a step in the right direction, it will be interesting to see how AutoZone balances its plans to grow its commercial segment while maintaining its best-in-class margins and its ability to keep working capital costs at a minimum.
The U.S. commercial aftermarket (as measured by wholesale dollar sales to professional installers) is still a very fragmented market. The top seven U.S. commercial providers command just shy of 19 percent market share (see Figure 1), indicating a Hirschman-Herfindahl Index (HH Index) value of 81.7 and negligible market concentration. Typically, an HH Index value in the range of 1,000 to 1,800 represents moderate industry concentration.
In this case, an 81.7 represents a high level of fragmentation. NAPA (Genuine Parts Company) leads the group with our estimate of $3.9 billion in annual commercial sales, followed by CARQUEST at $2 billion and Advance Auto Parts, Inc. and O'Reilly Automotive, Inc. with $1.2 billion in commercial sales each. While AutoZone might lag behind some of its peers (see Figure 1), it still generates upwards of $700 million in annual commercial sales and is a meaningful competitor.That being said, we continue to think that to be a truly successful competitor in the commercial segment, a company must commit wholeheartedly. That's a difficult task for most pure automotive retailers with a heavy DIY focus, especially AutoZone, whose investors have become accustomed to high levels of free cash flow and steady margin improvement. The decision to renew its focus on the commercial business might result in greater working capital demands, downward pressure on gross margins and higher inventory levels in general.
Management indicated that it had invested $70 million in additional hard parts inventory — about $32,000 per store with a commercial program — primarily in hard parts for older models to improve its order fill rates. We think there still is a much greater investment required to significantly move up the technician call list. We only point this out to keep investor expectations rational as AutoZone's efforts in the commercial segment are evolving constantly, and we don't anticipate a robust acceleration in trends to occur overnight.
Ultimately, we don't think the DIY business is going away. While its overall growth rate may moderate, AutoZone still should be able to maintain best-of-class margins, and its sizable cash flow should result in meaningful share repurchases to drive earnings growth and shareholder value.About BB&T Capital Markets:
BB&T Capital Markets is a full-service investment banking firm that focuses on specific industries, including the automotive aftermarket industry. BB&T Capital Markets is a division of Scott & Stringfellow, Inc.
Disclosures: BB&T Capital Markets expects to receive or intends to seek compensation for investment banking services from Genuine Parts Company; AutoZone, Inc.; Advance Auto Parts, Inc.; Midas, Inc.; and O'Reilly Automotive, Inc. in the next three months.
An affiliate of BB&T Capital Markets received compensation from Genuine Parts Company; AutoZone, Inc.; Advance Auto Parts, Inc.; and O'Reilly Automotive, Inc. for products or services other than investment banking services during the past 12 months. The analyst or employees of BB&T Capital Markets with the ability to influence the substance of this report know or have reason to know the foregoing facts.
Advance Auto Parts, Inc. and Midas, Inc. are, or during the past 12 months were, clients of BB&T Capital Markets, which provided non-investment banking, securities-related services to, and received compensation from, the subject companies for such services. The analyst or employees of BB&T Capital Markets with the ability to influence the substance of this report knows the foregoing facts.
BB&T Capital Markets makes a market in the securities of O'Reilly Automotive, Inc.
