Previous post in the series: https://quietprosperity.com/2023/09/23/old-blog-follow-the-fundamentals-altria-group-inc/

For business number three, I stayed in consumer land, but may have gone even more boring…

AutoZone Inc (AZO).

Everyone loves when their oil light comes on right?

As a quick refresher, the question is straightforward:

Based on what I have deemed to be important in business ownership, how many good stocks would I have actually identified along the way?

This is not to say I would have invested in them or even held for a long period, but would I have even given myself a chance?

Here is what I deem to be important:

• Profitable – Absolute (Positive Cash Flow), Efficiency (i.e. ROIC), Margins
• Healthy – Manageable Debt, Fundamental Volatility, Negative Accruals, Self-Funding
• Growing – Positive Top-Line & Operating over last few years (Recessions noted in analysis)
• Yield – Returning some cash profits to shareholders?
• Valuation – Reasonable in context of growth? Chance for expansion or limited contraction?

I don’t have too many industries I avoid outside of banks/commodities, so the universe is vast.

AutoZone Inc – $AZO

AutoZone is one of those companies that you wished you owned for the last 20 years. It’s boring, it’s predictable, it’s been levering up (More on this later), it’s almost always reasonable priced, if not cheap, etc.

It is one of those set it and forget it ownerships, which makes it outperformance even more remarkable. It’s had positive annual revenue growth for 27 straight years!

Here are the previous 20 years of financial data for AutoZone. Since this is about “fundamentals” I will be referring back to this picture quite a bit:

For a good comparison, you can also look at $ORLY. They basically have a duopoly in this business and their financials/results have been eerily similar over the last 2 decades.

AutZone Fundamentals

The Profitability history is pristine. The lowest 5-year average was 27% and that came right at the start of the period. It currently sits at 47% but has been as high as 66% (May I remind you this company sells air filters and carburetors). Operating margins have in the 13%-20% range over this period. Pretty darn good for a physical retail business. Free Cash margins snuck above 10% in 2010 and have not looked back. Again, for a retail business, yes please.

The financial health of the company has been strong for two decades now. Not a single red, orange or yellow flag coming from accruals, financing needs or balance sheet bloat over the last 20 years. The only other ? mark (And this goes for most mature companies) is debt loads. FCF/Debt has hovered around levels I tend to shy away from (Sub 20%). I know their cash-flows are very strong and AutoZone Inc does a good job of spacing out debt, but hard to keep that going forever and we have finally seen that tide shift a bit in the shareholder yield figures (More below). Am I worried about bankruptcy? No, but I do think levered buybacks are a tailwind that may not exist over the next 10+ years.

In terms of growth, there has been incredible consistent growth. 27 years in a row of positive revenue and gross profit growth. Even operating growth only declined in one year…one! Top-line seems to stay around 4%-5% and with some margin expansion, operating income comes in closer to 7%-9%. Very solid figures over such a long time frame.

AutoZone has been a buyback machine. They had 99.3MM shares in 2002 and have 21.1MM today, almost an 80% reduction in share count! That is incredible. Now some of that is from levered buybacks, as mentioned above. The company has been known to (very successfully) take out debt to perform buybacks, particularly before the last couple years (You can see that shareholder yield has historically been > than free cash flow yield). That trend is reversing it seems BUT the company seems committed to using every penny of FCF on buybacks, so capital will be returned.

Last is valuation. And despite the fundamentals being strong for so long, AutoZone’s valuation never really got too heated, until maybe the last year or two. Long-term average multiple was 12x cash profits. At today’s market-cap, it sits around 19x. It dipped sub 10x at various points in the last 20 years, most recently in 2017. Over this period, it would have been hard to argue buying a name at those multiples, with a 5+% yield, a chance for maybe 7%-9% growth in FCF, and profitability/margins like they have.

Today is a different question. It is a bit rich today for me, but the name will stay on the watchlist =)

Conclusion

There are some future questions about this industry as things shift to EVs. Will the corner auto parts store be as relevant? Will there be as many small ticket / easy fixes with EVs? These are questions I am not sure about as a DIY generalist.

There is no doubt ICE vehicles will be on the road for many more years, but has the company and industry reached the final boss? If it trades at sub 10x again in the short-term, I wouldn’t spend much time thinking about it, but at 19x, it’s something I would need to understand better.

As for the investment itself? I highlighted 2004-2014, 2016 and 2018 as years where I would have considered investment from a fundamental perspective. It checks every box in those years. Using a 10% hurdle rate I don’t think I would have had any sale concerns over this period either, until today (I have it at 8.5% TR guess over the next 5-10 years).

Again, who knows what questions I would have asked myself about AutoZone over the years. It’s very possible that the EV narrative would have made it to scary to buy, but by focusing on fundamentals, I would have at least given myself a chance at owning it. Not unexpected, but score another one for the “follow the fundamentals” theory.

Feedback and suggestions for future companies to look at are always welcome.

Have fun out there!