Michael Santoli makes a very good point in this week’s Barron’s. He argues that Americans have been conditioned for awhile now to shop intelligently and to get quality for the cheapest price possible. The last 3 months of fear have been the catalyst that permanently changes the American consumers from splurgers and spending machines into spendthrifts. Instead of buying a new one – we’ll mend it. (Except when you can buy a new one for the price of the mend)
My wife just informed that she purchased a $70 (her estimate of retail value) coat for my daughter for $15 at the Gap. My daughter’s current winter coat needs a new zipper that would have cost her $13 to fix. (No, I did not ask her how much it would have cost if she did it herself.
Santoli notices that its easier to defer purchases of new cars because they last longer. This does not bode well for a return to a pre-crash level of consumer car demand in the US. Keep it longer and fix it when it needs to be fixed. No need to get a new one when your current car is dirty. Santoli says:
The average age of cars on the road has been rising for decades and is up 50% since the 1980s, because they simply don’t fail as readily. So it’s become easier to defer the purchase of a new set of wheels, which may seriously pinch auto volumes and pricing for years.
Which brings me to AutoZone (AZO).
AutoZone is the largest specialty retailer of automotive parts and accessories to do-it-yourself individuals and professional installers. As of August 2008, the firm had 4,092 stores in the U.S. and 148 in Mexico. The company operates its commercial program out of 2,236 of its stores, offering delivery of parts to local, regional, and national repair garages, dealers, and service stations. The firm also sells ALLDATA automotive diagnostic and repair software.
We own AZO. We like it because:
1. AZO has high and rising economic profit and among the highest returns on invested capital above its cost of capital in retailing anywhere.
2. Variable compensation is tied to returns on invested capital.
3. Every dollar spent is subject to getting a 15% pre tax return – which means the company effectively only invests when it expects to receive positive economic value added.
4. With the average age of cars on the road at 9.5 years and rising, the $200 billion automotive after-market should benefit from increased demand. Sluggish new-car sales amid the uncertain economic climate also bode well for this trend.
5. Sales to professional installers represent a largely untapped source of revenue for the firm. AutoZone holds only 1.3% market share in this segment, leaving plenty of room to expand. This initiative will steadily add to returns on invested capital as increased capital turns more than makes up for thinner margins.
In spite of a very challenging macro environment, we believe our industry remains much more resilient than most. The two statistics we have consistently highlighted as the keys to our industry’s performance are the number of vehicles on the road and specifically the number of seven year old or older vehicles, or our kind of vehicles or OKVs as we call them, and miles driven. At this point, the number of new vehicle sales have declined significantly, while scrappage rates have not changed significantly. This leads to an aging U.S. fleet, which historically has been beneficial to us and our industry. William C. Rhodes, Chairman, President and Chief Executive Officer,Q1 2009 Earnings Call Dec. 9, 2008.
AZO’s stock was up 15% last year. We have owned this stock since we started Berk Advisory in 2002.
Its commitment to profitable economic growth since Eddie Lampert’s ESL became a large shareholder has confounded analyst after analyst who consistently had prodded the company to spend more on stores and on expansion and on acquisitions for fear of market share losses.
But analysts do not understand that AZO’s goal is not growth for growth’s sake or market share’s sake – the growth that matters is economic value growth. And that’s really nice.