Shorting AZO - AutoZone, Inc.

Description

AutoZone, Inc. (AZO) is a specialty retailer and a distributor of auto replacement parts and accessories.  They've opened over 4000 stores, most of them in the U.S., with some in Puerto Rico and Mexico. They carry product lines for cars, both new and re-manufactured, as well as some non-auto products. They sell their products online as well, including their AllData diagnostic repair software. However, they don't collect revenue from their repair or install services.

Background

Auto parts retailer AutoZone (AZO) is doing well since people, in the face of one of the most severe recessions in our history, are using what little cash they have left to work on their existing vehicles, as opposed to buying new ones. Reduced gas prices have also given car owners more incentive to work on their cars. And yes, AutoZone is actually doing well financially - that is, as far as revenue and income growth are concerned. But what about their debt? It's huge. So if they can't keep up their growth, look out below. If they can, and car sales continue to tank, there could be additional upside.

The Bears: AutoZone's Massive Debt Load

AutoZone, Inc. (AZO) carries a massive debt load, which will be unbearable once the company fails to meet its targets. It has been doing well thanks to declining car sales, and recessionary frugality making people invest in their existing cars as opposed to buying new ones. But AZO's stock price has already appreciated significantly, and while current ratios don't show it to be overvalued, those ratios also factor in a high and continuous expected growth and earnings rate, that we don't feel is viable in this economic environment. That will especially be the case if car sales pick up again. And when markets recover and the price of gas goes back up, the auto parts retailers stock prices will be brought back down to earth. Finally, with credit as tight as it is, the increase in financing costs on such a heavy debt load will undoubtedly impact earnings.

The Bulls: Stock is Worth $250/ Share

AutoZone, Inc. (AZO) has provided investors with steady EPS (Earnings Per Share) growth since the start of the decade. Despite their high debt load (some over $2 billion), they have enough assets on the books to bring their current ratio (assets/ debt) to a respectable 1.0 ratio (the industry average is 1.3). Some cash flow pricing models based on Warren Buffet's methods predict that the stock is worth almost $250/ share at its current levels. This value was derived by projecting EPS growth over the next decade, based on past EPS growth. Finally, AutoZone is obliterating its competition. O'Reilly Automotive and Advanced Auto Parts (AAP) have both done okay in the light of recent economic conditions, but Pep Boys stock is going straight down the recessionary toilet.