TIVP007: AutoZone (AZO): Under The Hood w/ Shawn O’Malley

25:11Looking at the business today, AutoZone is a company that dominates in-person retail, though it does have some online delivery options as well. The business runs through its 6 ,400 domestic stores and 930 international locations, with storefronts ranging from Mexico, Brazil, Puerto Rico, and the US Virgin Islands. Similar to Ulta, a portfolio company in the intrinsic value portfolio, AutoZone has a universal footprint design for its stores and plans for the types of areas they should be located in, creating a standardized and more uniform experience across all of its locations. In short, AutoZone looks for locations where they can offer an abundance of easily accessible parking spaces with store footprints between 6 ,500 and 8 ,000 square feet.

25:53And importantly, they require storefronts to be in what they call high-impact locations, where there's excellent visibility and access to the store from adjacent streets. This unwavering uniformity not only shapes a consistent customer experience, but ensures that new growth is done responsibly in accordance with what has been proven to work for the company. Last quarter, AutoZone opened 115 new stores, so this guidance is naturally very helpful to fall back on. Many US cities can support multiple auto zones, reducing the distance that customers on average have to travel. It's a little surprise that auto zone locations would be so conveniently located given the extent to which customer service is built into the company's culture.

26:32As Pitt Hyde put it to Fortune back in 2013, our objective was to build a culture around superior customer service and to have everyday low prices in good-looking stores. In 1991, we went public and the competition saw how well we were doing. They started copying our store layout and pricing, but none of them could copy our culture. And nothing exemplifies that better than the generous loan-a-tool program I mentioned earlier. I mean, seriously, how many other retailers would let you borrow, use, and then return a product they sell without really charging you for it? Obviously, refunds exist at all retailers, but typically not for used products unless they're faulty in some way.

27:13AutoZone simply helps customers out, lending them specialized tools as needed with no strings attached, which maybe if you've used the program, you'll disagree with. I haven't personally, but still, I think this sets the foundation for a lasting relationship where people will then be much more inclined to return to AutoZone specifically for all of their auto parts needs or recommend AutoZone to others. Digging into the unit economics of AutoZone some more, due to their stores mostly being in out-of-town locations, rents tend to be more discounted compared to other retailers. For the last 15 years, they've pretty consistently opened about 200 stores per year, spending around$500 million per year on CapEx.

27:52A store costs around$2.5 million to roll out, and they quickly pay for themselves. Sales per store are around$2 million, and those sales have historically grown organically at around 5 % per year on a same-store basis. And the ROI for new stores ends up being about 15 % or so in the first year, according to Freddie Late, CIO of Latitude Investment Management and longtime investor in AutoZone. That 15 % ROI for new stores is a very attractive incremental return on capital. I feel like I talk about this in every episode, but the returns an investor gets from buying stock today will largely be driven by the incremental returns on new capital investments the company makes going forward, rather than from the projects they've done in the past.

28:36When you account for the effects of debt and capitalizing long-term leases under the balance sheet that add leverage to the business and the higher profitability of existing stores, plus the fact that new stores tend to become more profitable over time and other efficiencies arise from economies of scale, the return on invested capital at the company level ends up being about twice as high as the ROI earned from new stores at around 30%. From a customer's perspective, perhaps showing why many are so loyal to Autozone, customer's journey is very efficient. It's official company policy that within the first 30 seconds of entering a store, an associate should come up to you and assess what you need help with.

29:14From there, it can be as simple as locating the part from these stores inventory and installing it for them and then sending the customer on their way after on average spending about$40. AutoZone wants to move people in and out quickly, not just for efficiency, but because car issues are stressful. And the sooner AutoZone can resolve an issue for a customer, the more grateful that customer will be. 85 to 90 % of DIY purchases are from customers who either have to get something fixed now or simply want to do so as quickly as possible. That expertise in resolving issues quickly is a big part of the barriers to entry that protect a retailer like AutoZone, which correspondingly has some unbelievably high margins for a retailer.

29:55Its gross margin is more than twice that of Walmart, which is on the other end of the retail spectrum in terms of quality and service, and it's probably more of a volume game rather than marking things up by 100 % or 200 % as AutoZone might. Making all of this possible is the impressive fact that around 90 % of the population lives within 10 miles of an AutoZone in the US. And a 10-minute drive to the store to deal with car issues and get professional help is not much at all. We talked about a similar dynamic with John Deere and its dealership network, but having a sprawling network that makes for a very convenient experience due to the accessibilities of stores is a real moat, especially against e-commerce focused competitors.

30:36Vehicle parts is a hard industry to do e-commerce for because there aren't many products that sell at high volumes. And what matters more is offering a wider range of options, which is costly from an inventory perspective for a company like Amazon. Overwhelmingly, customers like to come into stores and little tidbits of advice could be a big reason why. If you order a car part on Amazon, the delivery guy is not going to give you a tip on how to install it, but the employees at AutoZone will, regardless of whether you ordered in person or ordered online for store pickup. And even though inventory at a special retailer like AutoZone is longer lived, since many more obscure products might only be sold a few times a year, these products don't go obsolete in the same way that products at other types of retailers might.

31:19Windshield wipers aren't going out of style or use. And so even if you have some sit around for six months, you can be confident you will still sell them eventually, which again is not true for less specialized retailers. Walmart is not keeping crackers on its shelves for six months, nor is a clothing retailer going to keep summer clothes in stock if it's winter. It's worth mentioning that AutoZone isn't all about just facilitating DIY car repairs. They've built out a robust commercial business too, focusing on professional mechanics and repair shops. More than 90 % of AutoZone stores have a specific commercial program devoted to these types of customers.

31:55With knowledgeable staff to help guide professionals on complex repairs and the mega hubs I mentioned earlier that allow the company to offset a vast array of niche products, commercial relationships are an important and growing part of AutoZone's business. Thanks to these mega hubs, commercial customers can often get a part delivered in 30 minutes or less. Where the DIY market is more mature for AutoZone, the do it for me market, as it's known with the acronym DIFM, has been much more of a growth area, with AutoZone increasingly targeting customers who want maintenance on their vehicle done for them by professional mechanics.

32:29Since 2017, commercial sales have grown from making up about 21 % of AutoZone's US sales to 30%. Fending off Amazon is a dynamic I think we have to discuss with any retailer, as we did when studying Ulta. I discussed Amazon briefly already, but we need to go deeper. There are definitely parts you would never be able to order on Amazon and AutoZone employees provide a level of expertise that you'd lose out on by just ordering stuff on Amazon. Still, there are certainly smaller everyday items that might bring people into stores briefly that they could just as easily purchase online elsewhere. Unless you're absolutely certain about the type of oil or battery or whatever it is that you need, you're probably going to want to go into an AutoZone and just run it by them.

33:10That employee guidance is an important part of the moat that I think helps protect AutoZone's business. Since cars are so expensive and are such important parts of people's lives, car owners do not typically want to take risks when maintaining their vehicles. If it's something they can do themselves, they at least want to be certain they are, in fact, doing it right with the right parts or materials. AutoZone invests heavily in training employees to address what are sometimes highly specific questions from customers, and I'm not sure Amazon could or would want to try and rival that at scale. or even with something as simple as windshield wipers, it's not something you realize you need until it's raining, and then even next day delivery might be too long if you need them replaced now.

33:53Rather than ordering on Amazon in that case, you'd probably just pull into your local AutoZone and the crew members there will install them for you. There are many instances where you can't beat Amazon and its next day delivery, but for car-related things, I do think in-person stores with a vast selection of parts and expert service are hard to beat. Amazon does have a devoted automotive category though, and you can search for parts by car brand or product type and shop for discounted refurbished parts too. What's compelling as well is that you can basically upload your license plate and other vehicle details and save a vehicle to your profile.

34:27And then through Amazon's confirmed fit program, they'll tell you whether you're getting the right parts for your vehicle. That said, I dug into a subreddit devoted to mechanics giving each other advice. And the consensus seems to be that many of them do not recommend purchasing parts from Amazon due to quality concerns, saying they were too often either fake or from low quality suppliers. So I'm not currently sweating it out over Amazon, but people smarter than me have said that about different retailers and been terribly wrong. At this point, my feeling generally is that if a retailer has survived the onslaught from Amazon thus far, and as in AutoZone's case, hasn't just survived, but thrived, they deserve the benefit fit of the doubt.

35:06It's something to keep an eye on for sure. As one commenter on Reddit put it, they favor AutoZone because with AutoZone, I can be home and back in an hour. Amazon is at least two days out. I was surprised to see though that through a few different mechanics subreddit posts, AutoZone wasn't exactly getting glowing endorsements. My impression is that it was seen as an improvement over buying from Amazon, but the most popular recommendation by far was to instead purchase from a website called Rock Auto. Rock Auto doesn't sell any of its own private brands in the way that AutoZone sells Duralast, for example.

35:39They also don't have any physical stores or retail staff. And with a singular focus on selling auto parts online, unlike Amazon, this is a competitor that really gives me some pause, especially with how beloved it seems to be across car enthusiast forums. Prices on Rock Auto can apparently be half as much as what they're listed for at retailers like AutoZone. And I'd imagine that's because they have far less overhead costs than AutoZone, which has 100 ,000 employees and thousands of stores. Even the Rock Auto website is extremely basic. It looks like something from the 1990s. I'd imagine very little money comparatively is spent on maintaining the website for anything but functional purposes.

36:18And much of those overhead cost savings seem to get funneled into lower prices. The downside of little overhead is that from what I've read, Rock Auto doesn't exactly have very helpful customer service and its warranty programs on products can be spotty, where they don't always honor warranties or don't offer warranties of the same quality as AutoZone, which as a retailer is geared to have much better customer service and thus expects more returns and warranty issues. So they might otherwise be more generous or at least easier to work with. Rock Auto can also have fairly high shipping costs that nullify some of the cost savings for their listed prices relative to retailers.

36:54The other important difference is that where AutoZone and other auto parts retailers are trying to have every single type of obscure part you could ever need. So they're your go-to option in an industry with a mind-boggling amount of complexity and nuance at times. Rock Auto is more of a drop shipper, directly sourcing and selling what's needed. I'd guess that this makes them more like Timu than Amazon, where they're shipping directly from manufacturers. Rock Auto is not a public company, so I don't know their exact financials, but from what I've seen online, they're probably generating north of$100 million or$150 million in sales each year, which does make them a fairly substantial player.

37:29My bigger takeaway though, is that every mechanic has their own preferences and loyalties. Where they order from will depend a lot on the type of part and for which vehicle it's for. It also depends hugely on the urgency, which is the same shortfall that Amazon faces. If you need a part day of, whether as a DIY fix or as a mechanic fixing cars for customers, you're going to go to a physical store to get what you need. And as I said with Amazon, Rock Auto has been around since 1999, so this isn't some new competitor coming out of nowhere. I wasn't previously familiar with the company, but they've competed in the space for a while and evidently haven't prevented AutoZone from continuing to generate excellent returns.

38:06In part, I think this is largely because the auto parts industry isn't as price sensitive as other retail businesses. When I go through car enthusiast subreddits, this is clearly biased sample size where people are much more likely to be well-informed about what they're looking for and thus be more price sensitive. But on average, your typical AutoZone DIY customer knows little to nothing about car parts and their pricing. And as such, that knowledge gap leaves probably more room for pricing power. Personally, I would never feel comfortable ordering parts myself on Amazon. I'm exactly the type of person who wants to walk into an AutoZone, tell them roughly what I need help with, and then let them tell me exactly what I need and help me install it.

38:44Then for people who are more savvier about cars than myself, and I'll be the first to admit, I'm not very savvy. I think they have approximately the same experience unless they're truly a professional. If you were really cost sensitive, but not an expert, you could probably just go into an AutoZone and get guidance from them on what to order and then go and order it at a discounted price on Amazon or Rock Auto. But most people would probably rather opt for convenience. Just give me what I need when I need it, even if it's a bit more expensive. That convenience and knowledge gap is a big reason behind why AutoZone's business model has held up so well, despite e-commerce competition from Amazon, RockAuto, CarParts.com, and even eBay.

39:23So I'm not concerned about the in-store business dropping off, but I do think this e-commerce competition puts a cap on how much AutoZone's online business can grow. If there's time to shop around, people will do that online. But if your vehicle is part of your business or your only form of transport, that time is money. So the time cost of having to wait for a delivery is a real consideration in this market that balances out the higher costs of a retailer like AutoZone, which will carry whatever obscure part you need when you need it. One mechanic put it like this in a comment, quote, if you can wait for the parts, Rock Auto is pretty great.

39:58Can't use them most of the time though, because I've got a car on the hoist and a lineup of cars waiting. So I pay a premium to get the parts within the hour. To any listeners doing their own due diligence on a company, I really encourage you to check out what people say on Reddit about them, especially for consumer facing businesses. is the treasure trove of anecdotal comments and feedback from customers, employees, and competitors. And you can pick up a ton of great insights that, in combination, generate something of a mosaic of anecdotes that actually produces an informative picture of how the brand is perceived, how real people rely on it, and how it compares with alternatives and more.

40:32As I've touched on a bit already, AutoZone further positions itself to fight off Amazon by adapting its inventories to the needs of car owners within a close radius of specific stores. This isn't just about the types of vehicles people in that area tend to own, but also the average age of cars on the road in that town. Interestingly, there is a sweet spot for the ages of cars that are most valuable to a company like AutoZone. In a wealthy area where everyone has brand new cars, it's actually not very good for AutoZone because new cars don't need much service, or if they do, people will probably just take them back to the dealership.

41:05And in areas where there are a bunch of really old cars on the road, people are probably not interested in putting much money into maintaining them, or they may not have the income to do so. The sweet spot then is for cars between 8 and 12 years old, and geographies with higher proportions of those vehicles are very attractive to AutoZone because cars these ages will be outside of their warranties, but their owners will typically still plan to own them for another few years, making them more inclined to spend on maintaining them. Given that after seven years, warranties fall off and people rely on dealership networks much less for repairs, you can look at new car sales today and predict roughly what the market will look like for AutoZone in seven to eight years from now.

41:46That predictability of cash flows is something that makes AutoZone a fairly safe business to invest in. Basically, as cars age, the maintenance work on them increases roughly linearly. An eight-year-old car will probably need twice as much maintenance work as a four-year-old car. And as more new cars are sold every year, that adds to the collection of existing cars that increasingly have longer lifespans, thanks to better technology and construction. As the average lifespan for cars increases, so too does reliance on aftermarket auto parts. For context, the average age of vehicles in the United States reached a record high of 12.6 years in 2024, up by two months compared to 2023.

42:25This trend has been steadily increasing over the past decade to rising from an average of 11 years in 2012. So more cars than ever are in the sweet spot for AutoZone, with around 38 % of cars in the US being between 6 and 14 years old, which comes out to around 110 million vehicles. By 2028, that number is expected to grow 40%. We all remember how crazy used car prices got during the pandemic, and the elevated prices for new and used cars are likely to only cause people to hold on to their current cars for longer, contributing to the aging of vehicles on average across the US. And the average miles driven per year has tended to increase as well by around 1 % to 2 % per year, while the total number of cars on roads also increases by 1 % to 2 % per year.

43:12Another dynamic I like about AutoZone as a potential investment is that, in a way, it's sort of a counter-cyclical business. When the economy turns down, people will tend to hold off on new car purchases more, leaving them holding onto aging cars that need servicing. Let's take a quick break and hear from today's sponsor. Hey, it's Sean O'Malley, just popping in with a quick message. If you like this podcast, well, I've got great news for you. We've got a handful of other shows for you to explore, from learning about Bitcoin to embracing a richer, wiser, happier lifestyle. Just go into your podcast app and type in We Study Billionaires to find our collection of shows.

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46:50All right, back to the show. Now let's look more closely at AutoZone's retail competition. In many ways, the other major auto parts retailers are all pretty similar. Besides the fact that Napa uses a franchising model, they have similar footprints, store layouts, and business models, whether you're looking at Napa, Advanced Auto, O 'Reilly's, AutoZone, or Pep Boys. There are subtle differences like AutoZone catering more to DIY customers. In contrast, Advanced Auto caters more to the DIFM customers, which are those commercial segment of mechanics at auto shops who source parts to do maintenance for folks who want all the work done for them.

47:26Despite the similarities, the business outcomes have been very different. AutoZone has found lasting success over the last 25 years, while O 'Reilly's has found its stride more recently in the last 15 years, and advanced auto has faced much greater headwinds over the last decade. Advanced auto's gross margins are 13 percentage points below auto zones, and its returns are even more meager, with an average ROIC of just 6 % over the last five years, alongside completely flat revenue growth over the last three years, while net income fell by 90 % over the last two years. It's little wonder then that over 24 years, the stock has generated an average annual return of just 5%, not a good outcome for long-term shareholders.

48:09O 'Reilly's is actually very similar to AutoZone in terms of profit margins, revenue growth, returns on capital, and stock price returns. Without being an expert on O 'Reilly's just from a surface level, you could probably say that the company is of similar quality for long-term investors as AutoZone. I could imagine that somebody would do a joint portfolio where if they wanted to put 5 % into AutoZone, instead they put 2.5 % into both companies and spread out the idiosyncratic risk a bit since they're both excellent operators with similar track records. The market seems to have a preference for O 'Reilly's though, with its stock trading at around 30 times earnings versus 22 times earnings for AutoZone.

48:46Admittedly, that difference in valuation is why I chose AutoZone for today's episode. If there are two companies in the same industry with nearly identical results. I'm actually more interested in the one that Mr. Market is pricing more cheaply. Both companies trade at above their historical average price to earnings ratio, and O 'Reilly's has long traded at a premium relative to AutoZone. So I wouldn't say that this is an anomaly or that AutoZone is outlandishly cheaply priced. Looking at genuine parts company, ticker GPC, the parent company for Napa Auto Parts, it's managed less well and looks more like advanced auto as an inferior investment.

49:22Napa's net profit margin is about a third of AutoZone's. So per dollar of revenue, Napa converts much less into profit than AutoZone does. They also have a much more mediocre record in generating returns on capital and less efficient capital allocation, focusing on paying dividends rather than stock repurchases. I say that's less efficient because when a company pays you dividends, that money is coming from their own profits. I mean, that's money they already paid taxes on once. And now it's income for you as an investor and you have to pay taxes on it again. With share repurchases, ongoing shareholders don't have any sudden tax burden.

49:57The stock price might go up and when they sell one day, that will generate a capital gain. But you get to control when you sell and capital gains taxes are lower than income taxes. So I don't really love companies that blindly pay a dividend every year. I also don't want companies to do buybacks recklessly either, but I'd much rather have a thoughtful buyback program than pay income taxes on dividends every year that disrupts my compounding. That alone makes me less interested in Napa. And based on that aspect alone, it doesn't surprise me that the company has an inferior track record operationally.

50:30So to recap the major retail competitors, AutoZone and O 'Reilly's are the industry leaders in terms of size and operating results. And both of them are very compelling, but AutoZone trades at a more attractive valuation, even though I don't think there are major differences in their respective growth outlooks. AutoZone has also been more aggressive about buybacks, reducing its share count by twice the rate that O 'Reilly's has over the last decade. To play devil's advocate though, since O 'Reilly's stock is more expensively priced, it is probably prudent that they've been less aggressive about buybacks than AutoZone.

51:02One thing I do really like about O 'Reilly's is that despite having nearly the same amount of revenue as AutoZone, it has about a third less net debt. So AutoZone is a bit more financially riskier in that sense with a higher debt load, but much of that debt has actually been used to fund share buybacks and the debt load is still at manageable levels. Genuine Parts Company, which owns Napa, is a mediocre looking company on paper that I wouldn't put in the same high quality category as AutoZone or O 'Reilly's. They are also more spread out internationally. And advanced auto parts appears to be genuinely in trouble based on how dramatically its net income has fallen off.

51:38Maybe they will make for a good comeback story, but I think it's by far the least inspiring pick. They're actually pulling out of the West Coast of the US, so filling in the gaps left by advanced auto's exit will probably be a tailwind for AutoZone. Smaller mom and pop retailers have a place in the auto parts retail industry too, beyond these publicly traded names I've mentioned, but they lack the inventory availability and breadth that AutoZone has, making it difficult for them to compete seriously. So that's the picture of AutoZone's retail competition in the US. As I've teased a bit, though, AutoZone isn't entirely a domestic story.

52:12Mexico and Brazil are important regions for the company going forward, where AutoZone hopes to open 200 stores per year in these countries by 2028. At international locations, same-store sales have risen by double-digit percentages in the past few years, showing that the model AutoZone established in the US is replicable abroad. AutoZone has been operating in Mexico for over 20 years. It has around 800 stores there. The Mexican market is particularly attractive due to its older vehicle fleet, many of which are US cars, aligning well with AutoZone's inventory of products. With just over 100 stores in Brazil, this is more of an emerging growth opportunity.

52:46Brazil has a more varied mix of car makes and models compared to Mexico though. This diversity requires AutoZone to maintain a broader and more complex inventory system to cater to the needs of Brazilian customers. I think this is an often overlooked part of international expansions, but growth in emerging markets isn't necessarily as valuable as growth in the US or other developed markets. That stems from a few factors, not least of which is that countries like Brazil and Mexico have lower incomes than the US, meaning margins may be narrower, reflecting the reality that people there can't afford to pay the same markups.

53:19At the same time, these revenues are being earned in pesos or Brazilian real, which are historically weaker currencies that don't usually gain value against the dollar over time. In the past five years, for example, the US dollar has strengthened considerably at the Brazilian real's expense. In 2019,$1 bought you 4.16 real. Today, it buys you 6.17. That might not sound like a dramatic change, but that's a depreciation of 50%. Brazilian's purchasing power in US dollar terms is basically half of what it was just a few years ago. And you can't just raise prices by 50 % in Brazil to account for that because you'll just drive your customers to lower price domestic competitors who denominate their entire business in the local currency.

54:00So they're less concerned with the USD exchange rate. From the perspective of a US company that reports its financials in US dollars, that is a major challenge. They're earning revenue in Brazil or Mexico in real or pesos. And when they go to exchange those international revenues, they're worth fewer and fewer dollars. And like I said, for AutoZone, the number of dollars it generates is what matters. If revenues grow by 20 % in Brazil and real terms, but the real declines 20 % in value versus the USD, then AutoZone didn't report any growth in its sales. Any gains would be wiped out by a less favorable exchange rate.

54:37It's an extreme example, and this can go both ways over shorter periods of time, but the point remains. Looking at Mexico, one USD bought you roughly 11 pesos in 2003. Now it's more like 21. So this dynamic is occurring in both of AutoZone's main growth countries. I don't want to make it sound like it's pointless to expand in these places, but I do want this to be in the back of your head as you think through the company's growth prospects in the future, especially if much of that growth is coming from developing countries rather than in North America. While Amazon and e-commerce may at first seem like the biggest risk to AutoZone going forward, or the challenges of expanding operations abroad economically, I'd say the much bigger uncertainty is around how electric vehicles will change the auto parts market.

55:22That's because electric vehicles tend to have fewer parts than traditional gas-powered cars, meaning there are fewer components that can break and need repairs. Conventional cars can have over 30 ,000 different parts, whereas a typical electric vehicle might only have 15 ,000 different parts and one-fifth as many parts in the drivetrain. EVs will still break down and need service, but this will likely happen less often since EVs just have fewer moving parts and fluids. It's a vastly different maintenance experience with no oil changes, fuel filters, spark plugs, or timing belts. Even brake pads typically wear out more slowly in electric vehicles.

55:59That said, parts for EVs can be more expensive, and it can be harder to make DIY repairs on electric vehicles. So it's possible that as EVs make up a greater percentage of cars on the road, auto parts retailers can offset fewer parts sales with sales of more expensive parts, and services tailored to the unique issues with electric cars and hybrids. In South Korea, which is some of the highest rates of electric vehicle adoption in the world, the implications have been troubling for auto repair shops. Over the 13 years from 2010 through 2023, the number of automobile maintenance shops in South Korea declined by 1 ,000 stores, marking a roughly 25 % decline.

56:38From 2010 through 2023, the number of automobile maintenance shops in South Korea fell by 1 ,000 stores, marking a roughly 25 % decline. That trend would make me very nervous as a shareholder or employee of AutoZone. There could be unique factors contributing to this in South Korea, but still, I don't think it's a good sign. At a minimum, the closures of maintenance shops would spell trouble for AutoZone's commercial DIFM business if something similar happened in the US. As one maintenance shop owner in Seoul put it, even though EVs stopped by, the owners only ask to put air in their tires, and we can't make a living off that.

57:16In South Korea, the transition to more carbon-neutral vehicles has been particularly challenging for auto parts retailers and maintenance shops because the government gave out subsidies to those who scrapped older, less fuel-efficient cars. So that expedited not only the adoption of EVs and hybrids, but also took a bunch of older cars off the road who would have otherwise been in the maintenance sweet spot for a few more years. My feeling then is that South Korea is a more extreme case, but it does make me wonder over a longer time horizon whether a similar trend will ultimately play out in the US, and that possibility casts a big shadow over AutoZone's future.

57:51Based on conversations in California about completely banning gas-powered cars within the next decade or so, I think that could be one explanation for why advanced auto parts pulled out of the state altogether just by looking at this trend in electric vehicle adoption and maintenance shop closures in South Korea. And we haven't even mentioned the prospect of self-driving vehicles. These will still need to be serviced, but this could dramatically reduce the amount of DIY repairs that are done. If fewer people own cars themselves, because there are fleets of self-driving vehicles that you can basically call as an Uber whenever needed.

58:23This is all much further down the road, for sure, but I can imagine how self-driving cars could be a real paradigm flipper for AutoZone eventually. We've covered a lot, and now it's time to bring it all together with the valuation. Anyone can look at a stock chart or the chart of a company's price to earnings ratio, So doing that doesn't usually provide grand insights, but I do like to sort of disorient myself by doing so. Without overthinking things, it's pretty straightforward to look at the PE chart for AutoZone and see that it's at its highest levels in a decade. Meaning in other words, investors are paying the highest premium for the company's earnings that they have in 10 years.

59:00And unless the outlook for the business is the best that it has been in the last decade, which I'd guess it's probably not, you're setting yourself up for at least some headwinds working against you with the valuation. This is a stock where historically Mr. Market has paid$16 to$18 per share for a dollar of earnings. And now Mr. Market is paying closer to$22 for$1 of earnings. For a company of this quality, I don't think that's outrageous compared to O 'Reilly's, but mean reversion is a powerful force in markets. And I'd say it's more likely that the stock returns to a 17 PE than it is that it rises to 25 or 26.

59:36That doesn't mean AutoZone can't be a good investment, but it doesn't leave a ton of room for more optimistic assumptions. Considering the looming risks of secular decline for the auto parts industry, assuming EVs continue to be increasingly mainstream and also continue to need fewer parts and less maintenance over time than traditional vehicles, I was very surprised to see that AutoZone is trading near the highest price to earnings ratio in a decade. Ultra cheap Chinese EVs have become popular throughout the world, but they remain banned in the US and EV adoption in the US has generally been a bit slower, than some of the more optimistic projections would have anticipated a few years ago.

1:00:12So perhaps the stock's pricing reflects some optimism that the US will remain less EV dominated than other countries globally, which would probably help things continue to be business as usual for AutoZone. Looking at all five years, I would at best be comfortable with assuming sentiment around the stock remains the same, leaving its PE flat. And more conservatively, I want to assume a range of outcomes where the PE ratio declines to varying levels to see whether the company's growth and share repurchases can more than offset the pain inflicted by lower PE ratios. Over the last decade, AutoZone has compounded its total earnings by 8.5 % per year, while shrinking its shares outstanding by 7.3 % per year.

1:00:51Assuming the PE ratio hadn't risen at all, the stock would have compounded correspondingly at 15.8 % per year. The fact that the stock has compounded by more is because the price to earnings rose over that time as well, giving a further boost to returns that, as mentioned, we wouldn't want to continue to count on. A chunk of that earnings growth came during the pandemic though, so it is somewhat anomalous and I don't feel overwhelmingly confident that net income can continue to grow at more than 8 % per year. I used a similar model to the one I put together for Ulta previously since these are both mature retail businesses with strong track records of stable earnings growth and aggressive buybacks.

1:01:27The model is premised around net income growing modestly over the next four years at just 4 % per year, which is half of what it grew by over the last decade, while its total share count decreases by 5 % to 6 % a year, reducing the total share count by more than 26 % by 2030. That's a lot of buybacks to count on, about$19 billion worth to be exact in five years, but that is by no means out of line with the scale of buybacks AutoZone has consistently done for decades. With those assumptions and depending on whether the stock's price-earning ratio falls by 2030, remains flat, or rises, you get a pretty wide range of likely outcomes and returns.

1:02:03At the stock's current price of approximately$3 ,200 per share at the time of recording, the sentiment around the stock remains unchanged and it's trading at the same PE in five years. This implies a return of nearly 11 % per year. I think that's more optimistic than it sounds because AutoZone's business continues to mature and face challenges from EVs. Its price to earnings ratio is much more likely to decline than stay at current levels. If it were to revert closer to its mean PE of 18, this still implies a decent return of about 8.5 % per year. But if the valuation were to fall off to 14 times earnings, which is by no means unprecedented terrain for AutoZone stock, then that significantly offsets any growth in earnings per share and suggests a return of just 3 % per year.

1:02:47Let's not get bogged down too much by numbers, but in short, at current prices, I do not find AutoZone all that attractively priced. I think the range of plausible outcomes skews more negative than I'd prefer to see in a prospective investment. If you want access to the model I made for AutoZone, where you can play around with the assumptions for yourself and see how that impacts returns, make sure to sign up for the Intrinsic Value Newsletter in the show notes. In every newsletter, I share the model I use to value the company and make it available for free to download. Now, let me say that I still find AutoZone to be a very attractive business.

1:03:18It has a wonderful track record of operational success. And I love management's devotion to aligning incentives with shareholders and showing that in action by repurchasing such a massive amount of stock with their free cash flows. The buyback yield of 6 % or so, you don't need much growth in the underlying business to earn double-digit returns. It's just that the price you buy in at matters a ton, since there's probably not enough growth to bail you out if you overpay. You might be surprised, but I actually want to add AutoZone to the portfolio, but not at today's prices. In the meantime, I want to continue to better understand how electric vehicles will affect the auto parts industry, while also waiting for the stock to dip to a more attractive level.

1:03:56At around$3 ,000 per share, the range of plausible future returns looks more appealing to me. And below that level, I expect to build a starter position in AutoZone. Assuming nothing has materially gone wrong in the underlying business, the stock would have a more severe correction that brought it down toward$2 ,700. I expect to be adding into the portfolio quite aggressively with a position size on the larger end of the spectrum between 5 % and 10%. We'll see. Everything with investing is always subject to change. There could be concerning developments with the business that caused me to change my mind, and it's not guaranteed we'll ever get the chance to buy at these prices, but this is how I'm thinking about it currently.

1:04:32We don't get a correction in the stock. I'm happy to be on the sidelines because this isn't a screaming buy to me at today's prices, even with a long-term mindset. Again, if you're signed up for the newsletter, you can track changes to the portfolio each week and see how it's performing, So I definitely encourage you to do so. But that's all I have on AutoZone for now. I hope you enjoyed this deep dive into the company and exploration of its valuation. As always, I'd like to leave you with a timely quote before we go. Charlie Munger and his enduring wisdom reminds us that, quote, most people are too fretful.

1:05:03They worry too much. Success means being very patient, but aggressive when it's time. When the time comes with AutoZone, I hope to have the courage to be very aggressive. With that, folks, I'll see you again back here next week for another intrinsic value breakdown. And as one more reminder, if you're interested in hanging out with me and other value investors in Omaha on Berkshire weekend, we'll be hosting free to attend meetups on Friday and Saturday nights on May 2nd and May 3rd at the Blatt Beer and Table in downtown Omaha from 6 to 9 p.m. With Buffett at 94 years old, it may likely be one of your last chances to see the Oracle of Omaha in person, doing his usual Q &A at the annual shareholder meeting.

1:05:45So I hope you don't miss out if there's a chance you can still come. Please shoot me an email if you'd like to come to our free meetups at sean at theinvestorspodcast.com. That's S-H-A-W-N at theinvestorspodcast.com for more information. See you again next week. Thank you for listening to TIP. Make sure to follow the Intrinsic Value Podcast on your favorite podcast app and never miss out on our episodes. To access our show notes and courses, go to theinvestorspodcast.com. This show is for entertainment purposes only. Before making any decisions, consult a professional. This show is copyrighted by the Investors Podcast Network.

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