AutoZone Remains Neutral

We reiterate our Neutral recommendation on AutoZone Inc. ( AZO - Analyst Report ) , which is one of the nation’s leading specialty retailers of automotive replacement parts and accessories, operating in the Do-It-Yourself (DIY) retail, Do-It-for-Me (DIFM) commercial and other customer markets.

AutoZone released its fiscal 2011 third quarter results on May 24, 2011. The company reported net income of $227.4 million, up 12.1% year over year from $202.7 million. EPS of $5.29 comprehensively surpassed the year-ago quarter earnings of $4.12. Net sales improved 8.6% to $1.98 billion driven by higher sales volume coupled with an aggressive store expansion strategy.

AutoZone uses its significant cash flow to open new stores every year and maintain a mid-single-digit square footage growth rate. During the first quarter, AutoZone opened 43 stores in the U.S. and 12 stores in Mexico.

AutoZone is also focused on growing same-store sales by expanding private label offerings, which now account for 25% of sales. This business expansion policy undertaken by AutoZone is expected to reap long-term benefits through improved availability and customer services.

Another important factor is the aggressive share repurchases by AutoZone. The company repurchased 6.4 million shares of common stock at an aggregate cost of $1.1 billion during fiscal 2010.

In the third quarter of fiscal 2011, AutoZone repurchased 1.3 million shares for $339 million, at an average price of $267 during the quarter. At the end of the quarter, the company had $152 million remaining under its current share repurchase authorization. Each 1% reduction in shares outstanding increases earnings growth by 3%.

Moreover, AutoZone is the leader in the DIY retail market in the U.S. with a 13% share. The average age of cars on the road is rising, which is increasing the demand for auto parts.

Mexican revenues are likely to be robust due to an abundance of old cars in Mexico and a shortage of quality parts. AutoZone aims to tap this market potential by category management efforts and supply-chain initiatives in the retail segment.

Thus, depending on all these factors, estimates for AutoZone have shown upward trends following the latest earnings release, particularly for the upcoming two quarters. Twelve out of the eighteen analysts covering the stock for the fourth quarter upgraded their earnings estimates in the past 30 days, causing the Zacks Consensus estimate to go up to $6.93 from $6.80.

Similarly, ten out of the twelve analysts covering the stock for the first quarter of fiscal 2012 increased their estimates in the last one month. Accordingly, the Zacks Consensus estimate of earnings went up to $4.35 from $4.22 per share.

However, the main threat to AutoZone’s performance in the near term is rising debt on its balance sheet. AutoZone’s total debt increased to $3.22 billion as of May 07, 2011 from $2.70 billion as of May 08, 2010.

The second threat is the increase in costs, thereby affecting margins of the company. The recent appreciation in gas prices will also have a negative impact on miles driven and deferment of purchases by customers, again harming AutoZone’s business.

The third adverse aspect for AutoZone is its high reliability on its private label brands (50%), which could hinder its commercial business. Consequently, the company could face increased costs on account of higher staffing levels at the stores on top of rising occupancy costs.

Lastly, growing competition from companies like Advance Auto Parts Inc. ( AAP - Analyst Report ) , O'Reilly Automotive Inc. ( ORLY - Analyst Report ) and Pep Boys - Manny, Moe & Jack ( PBY - Snapshot Report ) may take a toll on AutoZone’s performance in the coming years.