A growing network of physical stores puts this company in a position to offer more consumers a wide selection of products as well as competent service. Although this company has improved profitability in each of the last 12 years, its shares are priced as if earnings would never exceed current levels. Favorable long-term industry trends, excellent management incentive structures, and a company with a growing competitive advantage make O'Reilly Automotive (ORLY) this week's long idea.
O'Reilly's stock represents a quality risk/reward considering that the company:
- Positioned to benefit from growth in mileage and vehicle stock globally
- growing network of physical stores bringing the brand to more new customers
- Steady and accelerating growth in market share
- accelerated growth strategy for professional clients
- Increase operational efficiency in your physical stores
- The valuation implies that the company will not increase earnings above current levels.
The demand for auto parts will grow with the world population of vehicles
US Energy Information Administration (PVP) reference case predicts that the global internal combustion engine (ICE) light commercial vehicle fleet will peak in 2038. However, the growth of electric vehicles (EVs) will continue to expand the overall global vehicle fleet, as the EIA projects that EVs will account for 31% of the global fleet in 2050, up from less than 1% in 2020. Overall, the EIA expects the global vehicle population to increase from 1.3 billion in 2020 to 2.2 billion in 2050, an annual growth rate of 2%, as shown in Figure 1.
Figure 1: Global Vehicle Inventory (ICE and EV) Reference Case: 2020 – 2050
Those:PVP
BUT FROMFORBES CONSULTANT
Maintenance costs will increase during the introduction of electric vehicles
Electric vehicles require less maintenance than internal combustion engines, leading some to wonder what the long-term growth prospects are for the aftermarket auto parts industry. However, the increasing adoption of electric vehicles does not mean that the general demand for vehicle maintenance or auto parts will decrease. Conversely, the increase in the number of vehicles in the global fleet will continue to increase overall maintenance needs through 2050, even as the introduction of electric vehicles reduces maintenance requirements per vehicle.
AAAyour travel expensesThe study found that EV maintenance, repair, and tire costs add up to $949/year, which is $330/year below ICE vehicles in 2019 (latest available year). If I apply these costs to the entire global fleet in 2020, maintenance costs for internal combustion engines were $1.664 billion compared to just $1 billion for electric vehicles. Assuming maintenance costs per vehicle remain the same for ICE and EV, total global maintenance costs will increase 2% per year, from $1.665 billion in 2020 to $2.605 billion in 2050.
Figure 2: Implicit maintenance costs[1]: 2020 versus 2050
Miles traveled are above pre-pandemic levels
Vehicle Miles Traveled (VMT) is another indicator of future demand from the auto parts industry. US SSS increased steadily from 107 billion in 1970 to 293.3 billion in 2019, a 2% annual growth. COVID-related lockdowns caused SMV to decline throughout 2020 and H1 21, but SMV has since recovered above pre-pandemic levels.
Figure 3 shows the two-year change in SSV by month. In six of the last seven months of 2021 (latest data available), SSS was higher than the same month in 2019. The pickup in demand growth beyond 2019 levels means that suppliers like O'Reilly they face even greater demand for their products. on, as more parts wear out with additional use.
Figure 3: Percent Change in Vehicle Miles Driven for Two Years per Month: 2019 - 2021
Those:Fred
EVs and autonomous driving will drive SMV higher
CorrespondentAAA, 43% of EV owners say they drive more miles than before after owning an EV. The increased VMT for EVS will likely offset the per-vehicle EV maintenance costs that EVs promise.
The same goes for self-driving cars... in the long run. Self-propelled technology creates a significant reduction inperceived travel time costs, which could result in motorists driving more often and for longer.
O'Reilly's extensive network of stores and distribution expands the moat...
To compete effectively in the auto parts retail industry today and in the future, O'Reilly leverages its extensive network of stores and distribution centers to provide customers with convenience, a wide selection of inventory, and expert customer service.
O'Reilly operates 5,784 stores totaling 43.2 million square feet with approximately 21,000 SKUs. However, stores have same-day access to two to four times the inventory of the largest hub and super hub stores, which have between 45,000 and 92,000 SKUs. Twenty-eight distribution centers also support stores with same-day or overnight access to an average of 158,000 SKUs. For reference, AutoZone (AZO) operates 6,785 stores covering 45.1 million square feet. AutoZone's Hub and Mega Hub stores sell between 40,000 and 110,000 SKUs.
As O'Reilly adds more locations and improves its efficiency, it becomes increasingly difficult to replicate your physical network. Nationwide box stores lack the geographic reach into smaller markets that O'Reilly's smaller stores permeate, while online competitors lack the convenience of a nearby physical location with experienced staff.
In addition, large retailers like Walmart (WMT) and online retailers like Amazon (AMZN) can't match O'Reilly's key advantage as a specialist: a wide selection of parts, backed by expert customer service.
...and expands market share
O'Reilly's goal is to win customers through service and stock availability. As the company enters new markets, it first establishes larger stores in more densely populated areas, and then adds clusters of secondary stores in sparsely populated areas with less competition. Larger stores offer same-day delivery to smaller stores with a thoughtful expansion strategy reminiscent of Walmart. O'Reilly's efficient distribution system, improved fill rates at its distribution centers, and strong supplier relationships allow the company to stock more inventory than smaller competitors.
This successful model helped double O'Reilly's share of the US auto parts business from 10% in 2012 to 20% in 2021. See Figure 4. In 2022, O'Reilly is aggressively targeting higher earnings from market share by reducing prices for its professional clients and opening 175 to 185 new stores throughout the year.
Figure 4: O'Reilly's Share of the US Auto Parts Business: 2012 - 2021
Those:IBISWorld
Same store sales growth is accelerating
O'Reilly's annual same-store sales growth has accelerated every year since 2017guideSame store sales growth of 5-7% in 2022 is lower than the previous two years, still above pre-pandemic levels.
Figure 5: Same Store Sales: 2017 – 2021
This forecast is likely to be conservative given the company's history of under-promising and over-profiting. According to Zacks, O'Reilly has beaten earnings estimates in nine of the past 10 quarters. Over the past four quarters, the company has outperformed earnings by an average of 22%.
Be more efficient with your footprint
As O'Reilly increases its number of stores from 5,019 in 2017 to 5,784 in 2021, it is also generating more revenue from its stores. As shown in Figure 6, the company's revenue per square foot increased from $244 in 2017 to $309 in 2021.
Figure 6: Sales per square meter of sales space in Germany: 2017 - 2021
Expenses go down while income goes up
As sales increased, O'Reilly also cut expenses. The company's selling, general and administrative expenses as a percentage of revenue decreased from 34% in 2017 to less than 31% in 2021.
Figure 7: O'Reilly's SG&A Spending: 2019-2021
Industry Leading Profitability
With revenue per square foot increasing and expenses decreasing, it's no surprise that O'Reilly's return on invested capital (ROIC) has improved year-over-year (YoY) for each of the last 12 years. The company generates industry-leading net operating profit margins (NOPAT), invested capital, and ROIC. See Figure 8. O'Reilly's NOPAT margin increased from 9% in 2010 to 18% in 2021, while invested capital increased from 1.1 to 2.1. Increased margins and invested capital drove the company's ROIC from 10% in 2010 to 38% in 2021.
Figure 8: O'Reilly vs. Profitability pairs: 2021
Room for more than one winner in the auto parts market
Readers may know that AutoZone (AZO) is one of my very successful Long Ideas, originally launched in November 2018. I think theAuto parts market in the United Statesit has plenty of room for two winners and that's why I'm bullish on both AZO and ORLY. Both companies have extensive sales and service networks that allow them to operate highly profitable businesses that will take business from smaller local and regional suppliers.
O'Reilly's management noted on theCall for results 4Q21that market share gains came primarily from "weaker independent competitors that have struggled with supply in recent years..." As the industry continues to consolidate, I expect AutoZone and O'Reilly to continue taking market share. disadvantaged market competitors will take. Combined, the share of the two companies in the US auto parts market was ~40% in 2021[2].
Steady growth in core earnings
O'Reilly's growing competitive advantages also ensure steady earnings growth. The company's basic income has increased year-over-year in each of the last 23 years. As Figure 9 shows, O'Reilly's core revenue grew from $27 million in 1998 (the first year in my model) to $2.2 billion in 2021, or 21% per year.
Figure 9: O'Reilly's Top Revenues and Earnings Since 1998
Fears that store growth is slowing are overblown
As O'Reilly's store network expands, it becomes more difficult to match historical growth rates. With stores in 47 states, O'Reilly's large network may leave some wondering how much room the company has left to expand the number of its stores nationwide.
The company's store count is showing signs of slowing down, as its 10-year CAGR of 4.5% is higher than its 3-year CAGR of just 3.5%. In 2021, the number of company stores grew at an even slower 3.0%.
However, a slower CAGR in store count doesn't mean O'Reilly has run out of opportunities to expand its physical network. On the contrary, O'Reilly's improved competitive position in its markets is likely to result in the exit of smaller and less efficient companies, giving O'Reilly more opportunities to increase the number of its stores in many of the markets it is currently targeting. those that already operate. compete is to increase.
Additionally, O'Reilly noted in his fourth-quarter 2021 earnings call that he still has a"Gap"in its national footprint. In the eight Northeastern states it currently serves, O'Reilly operates approximately one store for every 189,000 residents. For reference, O'Reilly operates one store for every 56,000 US residents across its entire network. This gap in the Northeast is hampering the company's ability to attract larger national accounts. Expanding its store network in areas like the Northeast offers the company more opportunities for growth on a national level.
Beyond new stores, O'Reilly has achieved 29 consecutive years of same-store sales growth. Despite new store growth slowing, the company has demonstrated its ability to increase sales through existing locations.
Continued growth even without a pandemic rebound
O'Reilly's revenue grew at a CAGR of 15% over the past two years, as government incentives gave consumers additional funds for repairs and maintenance that they might otherwise have put off. Also, with the large number of people working from home, DIY projects have become increasingly popular. However, as 2022 continues to move away from pandemic-related restrictions and there are no plans for more pandemic-related stimulus, the growth of DIY projects could slow.
However, the company's median revenue guidance for 2022 is still 8% above 2021 levels.
Profitability may improve despite tight margins
Rising costs and a more competitive pricing strategy could lead some to believe that the company will become less profitable in the future. However, the company has experienced significant sales growth in markets where it has tested its low-price strategy. O'Reilly anticipates that implementation of the company-wide pricing strategy will also result in sufficient revenue growth in its professional segment to offset lower margins.
In other words, I expect additional revenue from the professional segment to improve the company's returns on invested capital (revenue/capital invested) rather than increased costs depressing NOPAT's margins. As a result, I believe the company's return on invested capital (ROIC) will continue to grow.
The company's recent ability to improve its invested capital turnover gives me confidence that it will continue to do so as it executes its pricing strategy. Since 2017, the company's invested capital has improved from 1.6 to 2.1.
ORLY has a 52% advantage if the consensus is correct
O'Reilly's price-economy-to-book (PEBV) ratio of 1.0 means the stock is priced such that earnings will never increase significantly from 2021 levels. I use mine belowReverse Discounted Cash Flow (DCF) Modelto quantify the expectations built into the current share price and highlight ORLY's upside potential should earnings grow as analysts expect.
DCF Scenario 1: To justify the current stock price of $660/share.
Assuming that O'Reilly:
- The NOPAT margin drops to 17% from 2022 to 2031 (three-year average vs. 18% in 2021).
- Therefore, revenue will only grow at a CAGR of 1% from 2022 to 2031 (versus the 2022-2024 consensus CAGR of 6%).
The stock is worth $660 per share today, the current share price. In thisscreenplay, O'Reilly will win $2.4 billion from NOPAT in 2031, which is only 5% more than the 2021 NOPAT.
DCF Scenario 2: The shares are worth more than $1,000.
Assuming that O'Reilly:
- The NOPAT margin decreases to 17% from 2022 to 2031, and
- Revenue will grow 8% in 2022, 6% in 2023 and 5% in 2024, according to consensus estimates
- Revenue is growing at a CAGR of 4.5% from 2025 to 2031 (nearly half its 10-year revenue CAGR of 9% from 2011 to 2021).
the action is worth it$1,002/sharetoday: an increase of 52% over the current price. In this scenario, O'Reilly's NOPAT will grow by only 5% per year over the next decade, or one-third of the company's 15% NOPAT CAGR between 2011 and 2021. If O'Reilly's NOPAT grows accordingly at historical growth rates, then the stock has even more upside potential.
Figure 10 compares O'Reilly's historical NOPAT with his implicit NOPAT in each of the above DCF scenarios.
Figure 10: O'Reilly's historical and implicit NOPAT: DCF qualification scenarios
Sustainable competitive advantages will drive shareholder value creation
Here's a summary of why I think getting rid of O'Reilly's business will allow it to continue to generate a higher NOPAT than its current valuation suggests.
- Economies of scale through a large network of branches and sales nationwide
- Improving the economy of the same store
- strong customer service
- Industry Leading ROIC
What Noise Traders Miss at O'Reilly
Today, fewer investors are focused on finding dealers of quality capital with shareholder-friendly governance. Instead, due to the proliferation of noise traders, the focus is on short-term technical trading trends, while more reliable fundamental analysis is overlooked. Here's a quick summary of what noise traders are missing:
- long-term demand for cars and the parts needed to service them
- Industry-wide supply chain issues and an aggressive pricing strategy create opportunities for O'Reilly to gain more market share.
- ROIC has improved year-over-year in each of the last 12 years
- The valuation implies 52% upside potential, even if NOPAT is growing at half the rate of the previous decade.
If O'Reilly's new competitive pricing strategy for its professional services segment proves more successful than expected, investors could reward market share gains and accelerated earnings growth by raising the share price.
Share buyback could yield 3.6% return
O'Reilly does not pay dividends and has no plans to pay them in the future.
In lieu of dividends, O'Reilly returns capital to shareholders through share repurchases. From 2017 to 2021, the company repurchased $9.9 billion worth of shares (22% of current market capitalization). The Company has approximately $1.6 billion remaining in repurchase authorization. If the company exercises its remaining repurchase capacity in 2022, the repurchases will generate a 3.6% return at current market capitalization.
Executive compensation plans align the interests of executives with those of shareholders
Regardless of the macro environment, investors should look for companies with executive compensation plans that directly align the interests of executives with the interests of shareholders. Good corporate governance holds executives accountable to shareholders by providing incentives for prudent capital allocation.
O'Reilly rewards executives with salaries, annual bonuses and long-term stock awards. Most importantly, twenty percent of O'Reilly's annual cash bonuses are tied to the target return on invested capital (ROIC).
Linking executive pay to ROIC, which assesses the company's actual returns on the total amount of capital invested in the company, ensures that the interests of executives are aligned with the interests of shareholders, as there is a strong correlation between improving ROIC and increasing shareholder value.
O'Reilly's focus on ROIC has helped grow economic revenue from $414 million in 2012 to $2.1 billion in 2021.
Insider Information and Short Interest Trends
Over the last three months, experts bought 1,000 shares and sold 9,000 shares, with a net effect of ~8,000 shares sold. Those purchases represent less than 1% of its outstanding shares.
There are currently 871,000 shares shorted, which is 1% of the shares outstanding and just under two days to cover. Short rates have dropped 30% mom. The lack of interest in the short term shows that not many are willing to bet on shares falling from here.
Critical details found in financial records by my company's roboanalyst technology
Below are the details of the adjustments I'm making based on Robo-Analyst's insights into O'Reilly's 10-K:
Income Statement: I made adjustments of $315 million with a net effect of eliminating $179 million in non-operating expenses (1% of revenues).
Balance: Adjusted $356 million to calculate invested capital with a net decrease of $13 million. One of the largest adjustments was for $36 million in operating leases. This adjustment represented 1% of reported net assets.
Valuation: Made $6.9 billion of shareholder value adjustments to achieve a net effect of $6.7 billion of reduced shareholder value. Aside from total debt, one of the most notable adjustments to shareholder value was $373 million in outstanding employee stock options (ESOs). This adjustment represents <1% of O'Reilly's market capitalization.
Attractive backgrounds with ORLY
The following funds are highly rated and have a significant allocation to ORLY:
- Pacer U.S. Cash Cows Growth (BUL) – 5.3% allocation
- Acquirer Fund (ZIG): 3.4% allocation
- VictoryShares US Multifactor Minimum Volatility ETF (VSMV) - 3.1% Allocation
- Invesco Dynamic Market ETF (PWC) – Allocation of 2.8 %
- Hennessy Cornerstone Large Growth Fund (HILGX, HFLGX) – Allocation of 2.5%
Disclosure: David Trainer, Kyle Guske II, and Matt Shuler are not compensated for writing about specific stocks, styles, or topics.
[1] Implicit maintenance costs calculated fromPVPReference case for the global inventory of light vehicles andAAAaverage annual maintenance, repair and tire costs.
[2] AutoZone reports the number of national stores, which account for 89% of total stores, but not national revenue. I estimate AutoZone's 2021 domestic sales at 89% of total sales, or $13.5 billion.