Blackhat Loves ORLY ...O REALLY?!? I asked why.

theassetpro:

maybe i am wrong here....but aren't car sales going up due to the beginning of a new purchasing cycle and not necessarily improved economic conditions? My understanding is that due to the recession, many people have delayed purchasing new cars and instead have driven their old cars to the ground (as a result, this has increased the car purchasing cycle way above historical average).

If this is holds true and people are finally replacing their old junkers for newer cars, sales at autopart stores should take a hit.

Seems like the trade should have been at the beginning of the recession.

Thoughts?

Off the lot car purchases increased approx. 16% in 2012. In my opinion, I would say this is more so due to the deals on purchasing new cars right now, which if a new purchasing cycle is indeed in effect, will disappear. This could create a balancing effect.

And still, I think a lot of people are going from their run down cars to newer (used) cars. Rather than a brand new model.

barbariansatthegates:

BlackHat whats your take on the purchase of new cars in the NE. Due to sandy, will the average age of cars decrease in that area and thus dampen the NE expansion?

Definitely could, but being the boring value guy that I am, a one time event like that would only make me want to buy on weakness. The expansion is really just acquiring an already mature group of stores and a distribution center in Maine, so they don't need to build awareness and don't need an initial surge of customers or anything like that, but I never really thought of that as something that could permanently impair their move into the NE market.

AndyLouis:

now i have their song stuck in my head...

Totally forgot to mention that the biggest reason to be long is the jingle...

FutureBanker09:

Any thoughts about Ford? Sales for them continue to impress. Looking at the other side of the coin from AZO and ORLY.

Love Ford. But don't look at the businesses as opposites, where one gaining ground means the other has to lose it. In fact, more sales for F and its peers would mean more sales (albeit down the line) for ORLY and its peers. I'm personally long both in my PA actually.

Value Sleuth:

Why will they "always beat Autozone"? I haven't done any work on this name...

I meant to say "always beat Advance" there, should have corrected myself earlier. ORLY just has an overall stronger product offering, brand name, distribution network, etc. than AAP and that's kind of shown itself over the past few quarters. Even AAP management admits they've slipped, but they still have a much stronger presence in the Northeast so it'll be interesting to see if ORLY's strategy is to go head to head with them there and try to branch out more in those high-density areas. Traditionally ORLY kills it in the Midwest and now the West and South, but big pushes into the Northeast and potentially the Southeast could bode well for them if they can scoop up share from AAP and at least battle to a draw with AZO on the retail side. Commercial is the big differentiatior for ORLY and one of the reasons I like the growth profile for them better than, say, AZO, who generally has a stronger grip on Retail than its competitors.

Value Sleuth:

Ah, okay, thanks, BH. I know ESL loves Autozone, so I was interested in hearing why you like ORLY better. Thanks. You're the man.

Yah Eddie's a big AZO guy and there's definitely nothing wrong with them. If I had my way I would be long both ORLY and AZO. The industry has great economics and both have top notch positioning and management that delivers for shareholders. AAP has solid management as well but just not at the same level as the others, and definitely has slipped in terms of competitive position. If I wanted to hedge it out I guess long those two and shorting AAP wouldn't be the worst idea in the world. The correlations aren't what you'd expect though so it carries some risk I would rather leave off the table.

bear396:

I've always liked the auto aftermarket retailing industry. There are strong secular trends on the DIFM side of the business (which is a large part of ORLY's business) as cars get more complicated and the population ages and I think one thing that hasn't been mentioned is why the auto aftermarket retailers have strong protection against online competition - the pure number of SKUs required to be kept in stock along with the importance of service and support from an actually physical storefront are both difficult to replicate through online retailers. Coupled with the strong FCF conversion from negative working capital and favourable industry structure, it's definitely a great place to put money to work.

There are a number of issues that worry me though: (1) The North American auto fleet can only remain so old before it becomes too expensive to maintain. Given that it's at historic highs right now, I tend to be concerned that this trend is more likely to revert to the mean / slow down rather than continue to work so strongly in ORLY's favor (2) I was under the impression that some of the gross margin expansion was from inflationary pressures in 2009 - 2011 and that this was starting to slow (3) The synergies from converting CSK stores and integrating procurement / distribution should have started to slow by now. While they're continuing to expand, it's not at the same scale of CSK (which almost doubled their store base). That acquisition was a significant wind behind their sails for the last few years.

All these point towards slowing growth and if sales start to turn because of near-term cyclical trends, you'll see multiple compression (and negative working capital will start working against you from a cash flow perspective).

I will admit that compared to AZO, there's room for improvement especially on the leverage and working capital side and generally people believe they are up there with AZO as the best operators in the business. But I find it very difficult to underwrite 20% eps growth for another few years (and by extension the 19x earnings purchase price) when that's what the company has achieved over the last two years under significantly more promising circumstances (both operationally and in the macro environment).

you are right that maintenance is getting too expensive which is why you see more demand shifting to no-name brand items. for example prestone antifreeze sales have been declining significantly vs. private labels (same chemicals but one is more expensive given brand value). hence the declining margins on the supplier side and increasing price concessions among the suppliers and retailers. this is why you're seeing slight earnings volatility but will ultimately get pushed to the customers. keep in mind that you aftermarket is non-discretionary. a broke vehicle won't drive. so demand will always be there more so with the supporting macro factors stated above. additionally, keep in mind most suppliers and retailers are north america concentrated which is still very robust with respect to light vehicles (orly's core demographic). i would definitely agree aftermarket retailers is a good place to put your money.

bear396:

I've always liked the auto aftermarket retailing industry. There are strong secular trends on the DIFM side of the business (which is a large part of ORLY's business) as cars get more complicated and the population ages and I think one thing that hasn't been mentioned is why the auto aftermarket retailers have strong protection against online competition - the pure number of SKUs required to be kept in stock along with the importance of service and support from an actually physical storefront are both difficult to replicate through online retailers. Coupled with the strong FCF conversion from negative working capital and favourable industry structure, it's definitely a great place to put money to work.

There are a number of issues that worry me though: (1) The North American auto fleet can only remain so old before it becomes too expensive to maintain. Given that it's at historic highs right now, I tend to be concerned that this trend is more likely to revert to the mean / slow down rather than continue to work so strongly in ORLY's favor (2) I was under the impression that some of the gross margin expansion was from inflationary pressures in 2009 - 2011 and that this was starting to slow (3) The synergies from converting CSK stores and integrating procurement / distribution should have started to slow by now. While they're continuing to expand, it's not at the same scale of CSK (which almost doubled their store base). That acquisition was a significant wind behind their sails for the last few years.

All these point towards slowing growth and if sales start to turn because of near-term cyclical trends, you'll see multiple compression (and negative working capital will start working against you from a cash flow perspective).

I will admit that compared to AZO, there's room for improvement especially on the leverage and working capital side and generally people believe they are up there with AZO as the best operators in the business. But I find it very difficult to underwrite 20% eps growth for another few years (and by extension the 19x earnings purchase price) when that's what the company has achieved over the last two years under significantly more promising circumstances (both operationally and in the macro environment).

great analysis here. definitely something to think about that orly has a bit of an ace in the hole with the option to jack up their working capital leverage and push that AP/Inventory closer to the industry average. Not sure where they're at now but I last I checked they were around 70-75% while AAP does like 85% and AZO is actually something a step higher than that even. ORLY continues to open new locations and hopefully can see some margin padding thanks to the move towards more private label products and less demand for the Federal Mogul type parts that carry a much smaller gross margin. I feel confident they can continue to deliver mid-high teens eps growth over the near term, but the issues you brought up are certainly legitimate. That said, this is a business I plan on holding until I die, and we'll see a few more of this fleet cycles before then (hopefully), so I see it as one of the better long-term plays available for me right now, and there's certainly worse places one could put their money.

KarateBoy:

Fan of ORLY- my brother used to work there so I know it well from an operational perspective. In addition, I'm a car buy who built a 240sx from SCRATCH. AAP is not in the same league. It just feels 2nd class.

But, I disagree that online competition is curtailed by SKU count. In fact, I would argue its a reason why online retailer will succeed. Stocking SKUs in store is harder/more expensive than in a centrally located distribution center. If I was a bear, this would be central to a long-term bear thesis, but in the near-term all the other drivers of this business are too powerful.

I think the biggest hurdle for online retailers is:

1) Same-day service (most important) 2) Relationships with the store (important but there is fair amount of turnover) 3) Old generations (doesn't want to use internet but this is eroding)

Within the same auto parts space, I love LKQ. Very powerful moat.

The role of relationship when providing a service is one of the reason I'm bullish on GME.

Bullish on GME? That's a bold statement. Industry really seems to be turning obsolete, and relies on another slowly dying industry in game consoles. Not sure how big the service component is there but you may know better than me in that regard.

WhiteHat:

You must be very proud of yourself....

Not sure if this is in reference to ORLY or GME but..

Hard to find something that isn't up these days!

:)

stvr2013:

Glad I trusted an anonymous poster on an internet forum! But actually, great thread.

hats off to anyone who bought ORLY on random blackhat advice! hahaha.

cheese86:

Thanks for the insight. It's in my pile to at least look into. I don't think I'd pay 7x EBITDA for these guys but I wanted to do some work in case they hiccup on this new initiative and get much cheaper. I'll look into the others also but I suspect price will be an issue with my PM.

It will be, probably. If you have a mandate broad enough to allow for a 5+ year holding period then ORLY is still relatively reasonable at this level. But if you're looking for a shorter-term idea, the best case would be seeing Advance whiff on their next earnings and/or lower their full-year guidance, which they didn't do after this latest update on Q1 forecasts. They seem to think they'll be able to make up a lot of their comps in the back half of the year, particularly in Commercial growth, but honestly I'm pretty skeptical. I think the dirty little secret that holders of AAP would prefer not to consider is that Advance may be too late to the party in Commercial, second fiddle to AZO in Retail, and falsely attributing it to external factors when really they may be donating share to both ORLY and AZO as they try to increase their investment to push west and increase store count in the bigger markets like Texas and eventually Cali. I'd hold on though, their FCF yield is fantastic, especially relative to the other two in the oligopoly, and if it really is just some weakness in their core markets from weather and other externals it could start looking really cheap. I'm not yet comfortable with that idea yet though, especially given the rosiness of ORLY management lately in my talking with them. They seem to think the worst is behind now and they can comp 4% if they continue to execute... and that's never been much of a problem for those guys. They also have plenty of runway in the AP ratio whereas Advance is a lot closer to that 100% glass ceiling... I think they're at 90% right now and really working to push it up over the back end of 2013.