Why O’Reilly Is the Best Auto-Parts Stock; behind O’Reilly’s success is the right blend of distribution, parts, and availability, anchored by a strong culture

August 14, 2013 Leave a comment

TUESDAY, AUGUST 13, 2013

Why O’Reilly Is the Best Auto-Parts Stock

Credit Suisse says AutoZone and Advance Auto also screen well.

Credit Suisse

Last week, we toured an O’Reilly Automotive store, met with AutoZone management, conducted do-it-yourself channel checks and spoke with Advance Auto Parts post-second-quarter results. Our key takeaway is that the Big 3’s diverging top-line results may be better explained by differences in strategy than differences in geography and/or weather. The implication is that top-line performance gaps may continue to widen in the near-term. Flowing through previous second-quarter results we are updating our 2013, 2014, and 2015 earnings-per-share estimates for Advance Auto (ticker: AAP). We are also updating our target price for Advance Auto to $82 [from $75]. From a stock perspective, O’Reilly (ORLY) is our preferred name. Superior top-line momentum, CSK Auto store maturation, still easy compares and a strong margin profile point to ongoing upside and justify O’Reilly’s premium multiple, in our view.We believe AutoZone (AZO) screens well on a risk/reward basis, but we suspect that comparable sales have yet to meaningfully bounce back in weather impacted markets. Advance Auto also screens well on valuation but the second-quarter sales/expense tradeoff may raise questions about further top-line weakness.

O’Reilly stands out from a strategic perspective as well. Yes, O’Reilly’s comps are leading the industry, making it a logical call out. But behind O’Reilly’s success is the right blend of distribution, parts, and availability, anchored by a strong culture. CSK productivity gains are clearly helping, but core O’Reilly markets are also performing well. O’Reilly is quietly building up its import parts coverage (53% of cars) and is fully integrating it into its traditional offering. O’Reilly is also intensifying its do-it-yourself (DIY) efforts while others seem to be pulling back. As observed during our store tour, category resets, product adjacency changes and new diagnostic tools are enhancing O’Reilly’s DIY presence.

AutoZone leads in DIY and is pushing hard into commercial, but does not appear to be making progress as fast in commercial as it once was. During our meetings, AutoZone management acknowledged that it may take time for its commercial identity to resonate with jobbers. A factor that could be slowing adoption, in our view, is AutoZone’s brand strategy, which favors private brands over name brands.

Advance Auto has solid productivity in both sides of the business, but lags O’Reilly in commercial and lags AutoZone in retail. While Advance Auto is focused on commercial (i.e. distribution investments) retail footage reductions and an aggressive stance on retail labor productivity may be hurting retail comps. That significant focus on one side of the business is creating a potential challenge and may be coming at the expense of the other, something we believe bore out in second-quarter results. That said, we may be starting to see the initial signs of a key turning point for the company as Advance Auto’s new president (who is based in Roanoke [Advance Auto’s headquarters]) seems highly focused on areas that have held back Advance Auto relative to the other two players.

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Unknown's avatarAbout bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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