As a result, the total share count has shrunk by half in the last decade, and thus, earnings per share have increased dramatically, too, as the company’s profits are distributed across a smaller number of shares in the denominator.

In other words, investors who have held onto their stock have watched their ownership slice of the company pie grow over time as the company itself has also grown and become more valuable as well.

Over the last decade, earnings per share have risen by over 16% per year, with profit margins largely remaining intact.

Like I said, on paper, this is all really compelling, though I want to not only learn how they’ve found this success in the past but decide whether it can continue going forward, too.

To do that, let’s zoom out a bit.

[00:03:30] Shawn O’Malley: As Emil Persson writes for Quartr, Autozone is one of those companies that looks mundane and a bit unassuming at first glance. If you’re American, you more than likely have one close by that you drive past every once in a while. You’ve probably even stopped in to replace your wiper fluid or to purchase new headlights.

In just over 45 years, Autozone has grown to become the largest retailer of aftermarket automotive parts in the U.S.

The U.S. is a place built around cars; it’s fundamental to the average person’s experience and a defining part of our national identity here. Few things symbolize adventure and freedom more than a car driving west on the iconic Interstate 66 highway.

The country’s corresponding car-oriented infrastructure means that for things as simple as going to the grocery store, most Americans have to jump in a car to do so. Driving, is, of course, also the most popular way to commute to work and really the preferred form of travel for most everyday activities, especially for those who live in the suburbs and more rural areas.

More than 70% of U.S. workers commute to work daily by car, and per capita, car ownership in the U.S. is effectively the highest in the world, rivaled only by Canada, New Zealand, and Australia.

For every 1,000 people in America, there are 860 cars. Compare that with 700 for France, 389 for Russia, 612 for Japan, and 223 for China.

Americans’ car ownership towers over most of the rest of the world and most other developed countries, too.

All those cars, and all the miles on those cars, means that there is a massive industry around servicing vehicles and providing spare parts. This is also a fairly predictable market as well, where we know how old most cars on the road are, and, correspondingly, how likely they are to need maintenance and replacement parts as they age, depending on their make and model.

In this market for automotive parts, Autozone is the leading supplier and retailer, vying for market share over companies like O’Reilly’s Autoparts, Advance Autoparts, and NAPA Autoparts.

There are many smaller mom-and-pop retailers, on top of vehicle dealerships, that can all sell parts, making for rather fierce competition.

O’Reilly’s, Advance Autoparts, and NAPA are all publicly traded, too, so later on, I’ll go over their financials to see how they stack up.

[00:05:51] Shawn O’Malley: I want to discuss first how the company got to where it is today. The origins of Autozone do not trace back how you might think. Rather than being the product of some small-town parts business scaling up over time, the company doesn’t originally tie back to automobiles at all.

Instead, Autozone’s story begins in the late 1970s in Memphis, Tennessee, with J.R. Hyde the third, known simply as “Pitt.”

Pitt is the grandson of J.R. Hyde Senior, the co-founder of a grocery chain known as Malone & Hyde that got its start in 1907, spreading across the South and Midwest.

Pitt took over as CEO of the family business in 1972, and six years later, he was asked to join the board of directors of a little ol’ company called Walmart.

Working closely with Sam Walton, Walmart’s founder, rubbed off on Pitt; he looked to revitalize the Malone & Hyde grocery chain, which was facing growing competition, including from Walmart. Pitt began looking for more promising retail businesses to pivot into, from pharmacies to even sporting goods, but found that these areas had just as fierce competition.

While the automotive industry grew in the 1970s, with families owning more cars and making them an even bigger part of their lives, Pitt realized there was an opportunity to sell aftermarket automotive parts, and customers for car parts were far less price-sensitive than grocery shoppers.

As a long-time grocery exec, Pitt knew almost nothing about cars, but he did know a lot about retail businesses generally, and he figured he could find ways to fill in his knowledge gaps.

Four years after AutoZone made its debut, there were already 100 stores. That is some breathtaking growth, and along the way, Pitt became increasingly savvy. In each area a store operated in, they’d look up government statistics on which vehicles were owned in the surrounding areas to correctly anticipate which types of parts would be needed and in what volumes, and thus, every store had a different inventory profile.

In another innovative move, AutoZone further empowered customers by enabling them to simply call and order parts, which they could either pick up in-store or have delivered to their homes.

While this logistics network became more and more complex, it became clear that Autozone didn’t belong as a subsidiary of a grocery chain. In fact, the contrast couldn’t have been clearer, as the grocery business struggled with competition while AutoZone grew rapidly. By 1986, AutoZone was large enough to stand on its own and was correspondingly spun off as an independent company following a buyout led by the private equity firm KKR.

Now, management’s attention wouldn’t be split between two distinct businesses, and AutoZone could be managed how it saw fit. The other benefit of such a spinoff is that the company could raise its own capital without becoming further tangled with Malone & Hyde.

The first AutoZone popped up in the humble town of Forrest City, Arkansas, in 1979. The location was intentional, as larger cities often had plenty of places to service vehicles and buy parts from for DIY types, but smaller towns were more often overlooked. AutoZone’s plan, then, was to scale across rural America, selling to loyal customers without much competition.

Much of the inspiration for the original store came from Walmart, with the first AutoZone being brightly lit and offering a wide selection of products. Success came quickly, and by year 2, the company had 8 stores across 5 states, which then grew to 20 stores by the end of year 3.

As Pitt saw Walmart expand with policies focused on low prices, friendly staff, and welcoming stores, he made sure to implement those same characteristics at AutoZone. He also wanted to ensure that the customer experience was superior to other auto shops at the time, which were often messily organized and dimly lit.

Pitt felt it was also important that products be laid out in the store for customers to find themselves, rather than being concealed in a backroom or behind a counter where you had to ask a sales associate for help retrieving items.

These practices are common now, but part of the opportunity that Pitt saw was in noticing that automotive parts stores were largely not commercialized as optimally as they could be and certainly didn’t offer seamless customer experiences.

In the same year it spun off independently, Autozone launched Duralast, its own brand of auto parts, as well as its Loan-a-tool program, where customers can simply leave a deposit and borrow a tool for DIY fixes.

The Loan-A-Tool program is a perfect example of how AutoZone alleviates common pain points for its customers. Many vehicle repairs require specialized tools that can be prohibitively expensive for individuals who only need them for a single project, and the availability of the loan-a-tool program builds a great deal of goodwill with customers.

So long as customers return the borrowed tools, they receive a full refund on the price paid.

Duralast and the loan-a-tool program became core parts of Autozone’s identity, and as the company continued to vacuum up market share, it eventually went public on the New York Stock Exchange under the ticker AZO in 1991. In 1996, AutoZone purchased a company called AllData, specializing in automotive diagnostic and repair software, which remains an important tool that professional mechanics rely on AutoZone for to this day.

[00:11:30] Shawn O’Malley: While AutoZone has gone nationwide, the playbook has largely remained the same. Since its IPO, Autozone has compounded revenues at 10% per year on average while earnings per share has grown at a CAGR of 20.4% per year. It’s no surprise that the stock price has appreciated at the exact same rate, moving higher by an average of 20.4% per year over the last 24 years.

As much as this is a story about excellent capital allocation, where management has reliably grown profits at attractive rates and diligently repurchased stock, it’s also about so much more. Behind those profits and growth is a company that is well-run at every level.

[00:12:08] Shawn O’Malley: Its supply chain, for example, is strictly controlled, with so-called mega hubs acting as large distribution points, stocking up on a wide range of products, especially specialty products that might not be carried at smaller stores.

Around these hubs are AutoZone’s retail stores, aka satellite stores, which maintain their balanced inventory based on local demand, wielding a selection of typically around 23,000 products.

Bigger hub locations can carry around 50,000 different products, and the Mega Hubs can carry as many as 100,000 different products. What’s interesting about these mega hubs is that AutoZone originally only planned to open 20 or 30 of them, but as they’ve built them out, they noticed that nearby stores saw significant increases in sales, thanks to having a larger selection of inventory closer to customers, so AutoZone has learned that lesson and now aims to have 300 mega hubs nationwide.

As you can imagine, rural stores probably carry more truck parts, whereas stores in closer proximity to cities probably have more parts for compact cars and hybrids.

This setup, with relatively closeby mega hubs holding the widest selection of products, ensures that even obscure parts for, say, a 20-year-old car can be made readily available to customers as needed. As of 2024, AutoZone had over 100 so-called Mega Hub stores nationwide that act as the backbone of its wider distribution network.

There’s very much a balance between stores taking inventory of the most popular and relevant items for the area they operate in, and mega-hubs being sort of a safety net for them to fall back on, allowing customers to source almost any part imaginable.

That reliability is definitely not lost on customers. According to YouGov surveys, AutoZone recently ranked as by far the best auto parts brand.

[00:13:45] Shawn O’Malley: Further underpinning the company’s operating success is a concept I first discussed a few months back with Coupang, the South Korean e-commerce retailer that many like to compare to Amazon. If you haven’t listened to that episode already, definitely queue that up next, but the concept is negative working capital.

To simplify a bit, the idea is that AutoZone ends up receiving cash payments from customers upfront before it has to pay suppliers for the products it sells. That timing gap is a powerful advantage because, in the meantime, AutoZone can use that money in limbo to fund its own business. It’s sort of interest-free financing since you have collected money from customers but don’t yet have to pay the cost of goods sold for those items.

This is largely only possible thanks to decades of operating as a reliable and trustworthy partner for auto parts producers, as well as very efficient inventory management. If Autozone had a ton of inventory lying around for extended periods of time, it would not benefit from negative working capital in the same way or at all. That could actually be a sign that the company isn’t selling its inventory fast enough to meet its financial obligations, which isn’t the case here.

While Autozone doesn’t turn over its inventory all that fast, its wide product availability instead prioritizes customer satisfaction, while its leeway with suppliers, as mentioned, allows it to get paid upfront with some lag before having to compensate suppliers. One way you can actually see this in action is that AutoZone’s account payable, which is what it owes to suppliers, is 112% of the total value of the company’s inventory value.

So, that is a considerable amount of interest-free financing coming from suppliers, worth more than all of AutoZone’s inventory at the moment, and that directly translates into higher free cash flows.

Suppliers are willing to accept this, because no single supplier makes up a large chunk of AutoZone’s inventory, and because they source from so many different suppliers, AutoZone has most of the bargaining power. Suppliers largely accept this, though, because, for starters, AutoZone is a critical distributor for them, but also because an IOU from AutoZone is very trustworthy.

Even though AutoZone pays at a delay, they will pay, and that dependability and credit rating for AutoZone allows parts suppliers to go to banks and other lenders and basically say, look, AutoZone owes me a million dollars that they’re promising to pay in 90 days, if you lend me $980,000 today, you can have $20,000 in interest in three months when I get paid, and lenders will usually make that loan thanks to their trust in AutoZone as a counterparty.

I’m just making up numbers there, but you get the idea. AutoZone pays suppliers at a delay but with a pristine IOU, which allows suppliers to receive financing from other lenders, effectively making it so they’re still getting paid in a timely manner as well, in exchange for modest interest costs on that money.

It’s not an ideal situation for suppliers, but it’s not as bad or unsustainable as it might sound at first.

What’s great about AutoZone, and the sign of any true high-quality compounder, is how management has remained so focused on the variables that matter most for the owners of the business. Specifically, earnings per share and free cash flow, and the company’s track record in this regard speaks for itself. Plenty of management teams harp on the importance of these two things without actually consistently increasing either.

Or, worse, implementing incentive structures that grossly misalign with the interests of shareholders, rewarding managers for growing revenues at all costs at the expense of returns on capital.

An incentive structure that came at the expense of shareholders is the exact reason why I opted not to invest in Vital Farms last week, since they essentially give out stock not just to top executives but to all full-time employees, regardless of whether performance goals are even met, at least from what I could tell.

AutoZone is the opposite, being very stingy about dilutive stock-based compensation and more than making up for the effects of it with share buybacks that, on net, have greatly reduced the outstanding share count.

Bonuses at AutoZone are tied to economic profits, stemming from hitting nominal operating profit goals and even more shareholder-friendly metrics like returns on invested capital and diluted earnings per share. According to the company itself, it does so to, quote: “ensure that growth, as well as the cost of growth, are balanced and achieved in a manner that maximizes the long-term interests of our shareholders.”

Here’s more, quote: “We believe these metrics, when viewed over a ten-year horizon, provide a strong indication of whether our compensation program embodies not only a pay-for-performance incentive structure, but also a pay-for-long-term-performance incentive structure.”

Rather than chasing growth and pouring dollars into unfruitful projects that would simply expand the size of the empire that management rules over, Autozone has instead opted to repurchase between 3 and 10% of its outstanding stock each year over the last decade. I want to emphasize how rare that is. Imagine if you had hundreds of millions of dollars at your disposal; think about how tempting it would be to keep adding more and more stores so as to hire more and more people, which would all increase your personal clout from overseeing a bigger empire.

All that activity would be a ton of fun to oversee, even if none of it is creating value for shareholders.

As silly as it sounds, we all crave action, and growth is exciting. It’s interesting. 9 out of 10 people would surely choose to work at a growing company rather than a stagnant one, even if the growing company isn’t growing profitably.

And yet, AutoZone’s management team has had the discipline, which is a word I don’t use lightly, because this truly is discipline, to instead return billions of dollars to shareholders in the form of share repurchases, to the tune of nearly $40 billion since the inception of its share repurchase program in 1998.

Incredibly, that has underpinned a growth in earnings per share of more than 45,000 percent since IPOing, while repurchasing almost 90% of all of the company’s stock. I’ve honestly never seen anything like that before. It’s a borderline absurd amount of stock to repurchase.

Compounding earnings per share works in both directions, which I think people often forget. You can compound by growing earnings, or you can compound the decline in your share count to also grow earnings per share. And that compounding bears huge results for investors. A 90% decrease in shares doesn’t correlate to a 90% increase in earnings per share. Instead, it’s a 10-times increase.

So, a ten-fold increase in earnings per share from buybacks paired with a 10-fold growth in net income, is how you jointly get a 100x increase in earnings per share since 1998 for AutoZone. That is the recipe for a 100-bagger investment, where $1 invested turns into $100 after two decades.

And let me add that, from a quick look, this buying isn’t indiscriminate. It very much correlates to ups and downs in the stock, where the company repurchases more heavily in years when the share price is down.

I’m not saying that AutoZone has flawlessly purchased every bottom in the stock, but all in all, you can clearly see that the amount of stock they repurchase increases when the stock is declining and slows when the stock is rapidly rising.

You would hypothetically want to know not just whether more repurchases were occurring when the stock was depressed but also confirm that this was occurring at a price below the intrinsic value per share. Calculating that across time is a difficult thing to do, so as a rule of thumb, I’m pleased to see more aggressive repurchases when the stock is comparatively lower, which to me suggests that management is being mindful of the concept of intrinsic value and the tenets of good capital allocation.

[00:22:13] Shawn O’Malley: Looking at the business today, AutoZone is a company that dominates in-person retail, though it does have some online delivery options. The business runs through its 6,400 domestic stores and 930 international locations, with storefronts ranging from Mexico, Brazil, Puerto Rico, and the U.S. 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.

And, 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 U.S. cities can support multiple AutoZones, reducing the distance that customers, on average, have to travel. It’s little surprise that AutoZone locations would be so conveniently located given the extent to which customer service is built into the company’s culture.

As 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.”

Nothing exemplifies this 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 charging you for it?

Obviously, refunds exist at all retailers, but typically not for used products unless they’re faulty in some way.

AutoZone simply helps customers out, lending them specialized tools as needed, with no strings attached, which I’m sure 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.

[00:24:37] Shawn O’Malley: 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.

A 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 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 Lait, CIO of Latitude Investment Management and long-time 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.

When you account for the effects of debt and capitalizing long-term leases onto 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 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, the customer 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.

From there, it can be as quick as locating the part from the store’s vast inventory and installing it, 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. 85-90% of DIY purchases are from customers who either have to get something fixed now or simply want to do so as quickly as possible, and 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.

Its 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 is playing more of a volume game rather than marking things up by 100 or 200% as AutoZone might.

Making all this possible is the impressive fact that around 90% of the population lives within ten miles of an AutoZone in the U.S. And a ten-minute drive to the store to deal with car issues and to 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 accessibility of stores is a real moat, especially against e-commerce-focused competitors.

Vehicle 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 isn’t 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 specialty 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. Windshield wipers aren’t going out of style or use, and so even if you have some sit around for 6 months, you can be confident you will still sell them, which again isn’t true at many less specialized retailers.

Walmart isn’t keeping crackers on its shelves for six months, nor is a clothing retailer going to keep summer clothes in stock if it’s winter.

[00:28:41] Shawn O’Malley: 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.

With knowledgeable staff to help guide professionals on complex repairs and the mega hubs I mentioned earlier that allow the company to offer 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.

Since 2017, commercial sales have grown from making up about 21% of AutoZone’s U.S. sales to 30% today.

[00:29:38] Shawn O’Malley: Fending off Amazon is a dynamic I think we have to discuss with any retailer, as we did when studying Ulta, too. 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. That employee guidance is an important moat that 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. Rather than ordering on Amazon, in that case, you’d probably just pull into your local AutoZone, and the crewmembers 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, and 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 seemed 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.

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 of the doubt.

[00:31:58] Shawn O’Malley: It’s something to keep an eye on for sure. As one commenter 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 mechanic 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. They 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 RockAuto 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, and 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.

The 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 Temu than Amazon, where they’re shipping directly from manufacturers.

Rock Auto isn’t a public company, so I don’t know their exact financials, but from what I’ve seen, they’re probably generating north of $100 million or $150 million in sales each year, which makes them a substantial player.

My bigger takeaway, though, is that every mechanic has their own preferences and loyalties, and 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 ya need.

And as I said with Amazon, RockAuto 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.

In 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 a biased sample size where people are much likelier to be well informed about what they’re looking for and thus 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 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. And even for people who are much savvier about cars than myself, 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 go into an AutoZone and get guidance from them on what to order, and then go order it at a discounted price on Amazon or RockAuto, but most people would 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, Rock Auto, CarParts.com, and even eBay. So, 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 this 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. Can’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 a company, especially for consumer-facing businesses. It’s a 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, how it compares with alternatives and more.

[00:37:34] Shawn O’Malley: As 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. And 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, that’s actually not so good for AutoZone because new cars don’t need much service, or if they do, people will probably take them back to the dealership.

And 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 these 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 well.

Given that after 7 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 a company like Autozone in 7-8 years from now, and that 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 8-year-old car will probably need twice as much maintenance work as a 4-year-old car.

And as more new cars are sold every year, that adds to the collection of existing cars that, increasingly, have longer life spans, thanks to better technology and construction. As the average life span 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. This trend has been steadily increasing over the past decade, too, rising from an average of 11 years in 2012.

So, more cars than ever are in the sweetspot for AutoZone, with around 38% of cars in the U.S. being between 6 and 14 years old, which comes out to around 110 million vehicles. By 2028, that number is expected to grow to 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 onto their current cars for longer, contributing to the aging of vehicles on average across the U.S.

And the average miles driven per year has tended to increase as well by around 1-2% per year, while the total number of cars on roads also increases by 1-2% per year, fueling combined growth in the underlying vehicle servicing industry of 3-4% per year in aggregate.

Another 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.

[00:40:20] Shawn O’Malley: 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 the commercial segment of mechanics at auto shops who source parts to do maintenance for folks who want all of the work done for them.

Despite the similarities, the business outcomes have been different. AutoZone has found lasting success over the last 25 years, while O’Relly’s has found its stride more recently in the last 15 years, and Advanced has faced much greater headwinds over the last decade.

Advanced Auto’s gross margins are 13 percentage points below AutoZone’s, and its returns are even more meager, with an average ROIC of just 6% over the last 5 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.

O’Reilly’s is actually very similar to AutoZone in terms of its 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 can probably say that the company is of similar quality for long-term investors as AutoZone.

I could imagine that somebody would do a joint position in their 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. Admittedly, 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 naturally 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. NAPA’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, meaning 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. The 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 disrupt 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.

So, 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’s prudent that they’ve been less aggressive about buybacks.

One thing I do 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, and they are also more spread out internationally.

And Advanced Auto appears to be genuinely in trouble based on how dramatically its net income has fallen off. Maybe they will make for a good comeback story, but I think it’s by far the least inspiring. They’re actually pulling out of the West Coast of the US, so filling in the gaps left Advanced’s exit will probably be a tailwind for AutoZone.

Smaller mom-and-pop competitors 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.

[00:45:40] Shawn O’Malley: So that’s the picture of AutoZone’s retail competition in the U.S. As I’ve teased at a bit, though, AutoZone isn’t entirely a domestic story. Mexico 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 U.S. is replicable abroad.

AutoZone has been operating in Mexico for over 20 years and has around 800 stores there. The Mexican market is particularly attractive due to its older vehicle fleet, many of which are U.S. cars, aligning well with AutoZone’s inventory of products.

With just over 100 stores in Brazil, this is more of an emerging growth opportunity. Brazil has a more varied mix of car makes and models compared to Mexico, though. And this diversity requires AutoZone to maintain a broader and more complex inventory to cater to the needs of Brazilian customers.

I think this is an often overlooked part of international expansion plans, but growth in emerging markets isn’t necessarily as valuable as growth in the U.S. or other developed markets. That stems from a few factors, not least of which is that countries like Brazil and Mexico have much lower incomes than the U.S., meaning margins may be narrower, reflecting the reality that people there can’t afford to pay the same mark-ups.

At the same time, these revenues are being earned in pesos or real, which are historically weaker currencies that don’t usually gain value against the dollar over time. In the last 5 years, for example, the U.S. dollar has strengthened considerably at the Brazilian real’s expense. In 2019, one dollar 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%. Brazillians’ purchasing power in U.S. dollar terms is 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 will just drive your customers to lower-priced domestic competitors who denominate their entire business in the local currency, so they’re less concerned with the USD exchange rate.

From the perspective of a U.S. company that reports its financials in U.S. 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 in real terms, but the real declines 20% in value versus the USD, then AutoZone can’t report any growth in its sales. Any gains would be wiped out by a less favorable exchange rate.

That’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, and 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.

[00:48:31] Shawn O’Malley: 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. That’s because electric vehicles tend to have fewer parts than traditional gas-powered cars, meaning there are fewer components that can break and need repair.

Conventional cars can have over 30,000 different parts, whereas the 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.

That 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 has 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.

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 U.S.

As one maintenance shop owner in Seoul put it, “Even though EVs stop by, the owners only ask to put air in their tires, and we can’t make a living off that.”

In 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 that would otherwise have 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 U.S. That possibility casts a big shadow over AutoZone’s longer-term future.

And we haven’t even mentioned the prospect of self-driving vehicles. These will still need to be serviced, but it 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.

This is all much further down the road for sure, but I can imagine how self-driving cars could be a paradigm flipper for AutoZone eventually.

[00:51:59] Shawn O’Malley: 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 just orient myself by doing so.

And without overthinking things, it’s pretty straightforward to look at the P/E 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 the past decade, and unless the outlook for the business is the best it has been in the last decade, which I’d guess it’s not, then you’re setting yourself up to at least have some headwinds working against you.

This is a stock where, historically, Mr. Market has paid $16-18 per share for a dollar of earnings in the past year, 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 P/E than it is that it rises to 25 or 26.

That 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.

Ulta-cheap Chinese EVs have become popular throughout the world, but they remain banned in the U.S., and EV adoption in the U.S. generally has been a bit slower than some of the more optimistic projections anticipated, so perhaps the stock’s pricing reflects some optimism that the U.S. market will remain less EV-dominated than others globally, which would probably help things continue to be business as usual for AutoZone.

Looking out five years, I would, at best, be comfortable with assuming sentiment around the stock remains the same, leaving its P/E flat. And more conservatively, I will want to assume a range of outcomes where the P/E ratio declines to varying levels to see whether the company’s growth and share repurchases can more than offset the pain inflicted by lower P/E ratios.

Over the last decade, AutoZone has compounded its total earnings by 8.5% per year while shrinking its outstanding shares by 7.3% per year. Assuming the P/E ratio hadn’t risen at all, then the stock would have compounded correspondingly at 15.8% per year, which is just 8.5% + 7.3%.

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 could continue to grow at more than 8% per year.

[00:54:44] Shawn O’Malley: I used a model similar 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. The 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 the total share count decreases by 5-6% per 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 done consistently for decades.

With those assumptions, and depending on whether the stock’s price-to-earnings ratio falls by 2030, remains flat, or rises, you get a range of likely outcomes and returns.

At the stock’s current price of approximately $3,200 per share, if sentiment around the stock remains unchanged and it’s trading at the same P/E 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 faces 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 P/E of 18, this still implies a decent return of about eight and a half percent per year. But if the valuation were to fall off to 14 times earnings, which is by no means unprecedented terrain for AutoZone’s stock, then that significantly offsets any growth in earnings per share and suggests a return of just 3% per year.

Let’s not get too bogged down by numbers, but in short, at current prices, I do not find AutoZone all that attractively valued, and I think the range of plausible outcomes skew 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 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 used to value the company and make it available free to download.

Now, let me say that I still find AutoZone to be a very attractive business. It 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.

With a 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.

[00:57:05] Shawn O’Malley: I 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. At around $3,000 per share, the range of plausible future returns looks much 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, if the stock were to have a more severe correction that brought it down toward $2,700, I expect to be adding it to 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 cause 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.

If we 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.

[00:58:16] Shawn O’Malley: But that’s all I have on AutoZone for now. I hope you enjoyed this deep 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, in his enduring wisdom, reminds us that, quote: “Most people are too fretful, they 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 ya again back here next week for another intrinsic value breakdown.

And as another 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 meet-ups on Friday and Saturday nights on May 2nd and 3rd at the Blatt Beer & Table in Downtown Omaha from 6 to 9pm.

With Buffett at 94 years old, it will 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, so I hope you don’t miss out if there’s a chance you’re able to come.

Please shoot me an email if you’d like to come to our free meet ups at shawn@theinvestorspodcast.com, that’s S-H-A-W-N at theinvestorspodcast.com for more information. See you again next week!

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