AutoZone, Inc. (AZO) Earnings Call Transcript & Summary

So our next presenter is one of the largest distributors of aftermarket parts in North America. We're lucky to have them, AutoZone. AutoZone has 20 million shares, at $2,300, $45 billion market cap, net debt of $5.9 billion for an enterprise value of $50 billion. Speaking with us today is CFO, Jamere Jackson. Thank you, Jamere, for being here.

That's great. Good to be here. I also have Brian Campbell, who's Head of Investor Relations and Treasury, with me here today as well.

I cannot tell if he was going to make it. Thank you, Brian, as well for being here.

So first of all, congratulations on very impressive results. I think they have been a surprise to us all on the upside. So just to reiterate for everyone, you posted a 3-year stack of 32% in relation to automotive aftermarket, which kind of generally grows 2% to 3%. Can you kind of just talk about what you do, what you sell and how you -- how you generate that kind of growth in this type of environment?

Yes. So we've been in the business, obviously, over 40 years. We started primarily on the DIY side of the business. We introduced our commercial program in 1996, and our business has been really remarkably resilient through the cycles. If you look at our performance over the last decade or so, earnings being consistent and steady, up almost 18% compounded annually. And from a share price standpoint, we've compounded at about 19.5%, almost 20% compounded annually during this time frame. So 2 portions of our business, our DIY customer is a customer obviously that comes in to our stores, buys parts, gets advice from an AutoZoner across the counter, usually will have an opportunity for certain things to do installations like batteries and wiper blades and lighting and those sorts of things. That customer gets an opportunity to have expert advice from an AutoZoner and has been pretty resilient through the cycle. Even as technology has changed over time, we've got a very strong DIY customer. Our DIY business has been roughly 70% to 75% of our domestic auto parts business pretty consistently through the cycles. And what we're really excited about more recently is the growth that we've seen on the commercial side of the business or the Do-It-For-Me side of the business, where, as I mentioned, we started in this business really around 1996. And it's grown remarkably. We finished last year a little over $4.2 billion of sales, grew almost 27%. We have commercial programs and about 87% of our DIY footprint. So as I think about our business going forward, it will be a much bigger portion of the story, if you will.

And before we kind of touch on that because it has been amazing growth, can you just -- do you have a breakout of kind of what you would consider a discretionary maintenance or failure part across what you sell?

Yes. So in our stores, I mean, we typically have our sales floor categories, which has more discretionary portion of the business, if you will. So think of discretionary purchases as things like wash and wax, car mats, hub caps, those sorts of things. And that's been roughly 15% of our business pretty consistently over time. And then our -- the bread and butter of our business, obviously, roughly 85% is in the failure and maintenance categories. Maintenance kind of categories being things like people that are doing oil changes and then our hard parts where people are doing fairly significant maintenance either under the hood or under the car, if you will.

Yes. Great. Because, I mean, I guess it just leads into the question, just how are you able to maintain this -- your impressive margins with the 10% inflation?

Yes. One of the neat things about our business is that, number one, pricing has been very rational during this environment. And it's been rational, quite frankly, for decades. I mean we have the luxury, if you will, of having a business that has relatively inelastic demand, if you will. So if you think about the failure and maintenance portion of our business, which, as I said, is about 85% of the business, it is largely a break-fix business. And so as a consumer is experiencing failures of car parts, and they're going to go spend money to fix those cars over time. And so as we've seen inflation, even if it's hyperinflation, we've been able to take those costs and pass it along to our customers in terms of higher retails. And again, the industry has been very rational in this regard and has done that literally for decades.

Yes. And have you seen -- I mean it does not sound like this, but any signs that the consumer is not willing to take any more price increases?

Well, I think a couple of dynamics are there. Number one, as I mentioned, sort of the inelasticity of demand for certain elements of our business. I think a couple of things really stand out to us in terms of the market environment. Number one, we're seeing consumers that are faced with lots of inflation in lots of places. But if you think of the essential nature of mobility and people have in their cars, maybe other discretionary portions of retail outside of our industry are certainly feeling the pain associated with higher inflation. So there's no question, when you see food prices and rent and utilities, fuel prices, all of those things start to have an impact on the customer. Even in our industry and that more discretionary portion of the business, you'll see consumers maybe pull back a little bit there. But again, for the bread-and-butter portion of the business, customers are still spending money. I think the second dynamic that we've seen during this cycle as well is that the car part continues to grow. The average age of the vehicle is now over 12 years old. And you've had this backdrop, this macro backdrop of challenges associated with the new and used car market, where used car prices are up probably 40% prepandemic. Used car prices are in a similar ZIP code, maybe closer to 30%. And so as consumers have been faced with the alternative in some instances of repairing their vehicle to ride to the other side of a more difficult or more uncertain environment, the price associated with -- and the availability associated with new and used cars has caused customers to continue to invest in their vehicles in a meaningful way. And that's certainly been a tailwind for our business as we've seen over the last couple of years or so. So again, the industry dynamic has been healthy. If you think about our business as we move through the pandemic, we've had the opportunity to benefit from multiple rounds of economic stimulus, which caused our business to spike. And then as some of those purchase occasions tailed off, the hole is basically filled in by inflation and pricing. We want some market share during this time frame, and you've got a macro environment where consumers are inclined to invest in their vehicles to sort of ride to the other side here. And we've been able to benefit from those robust market conditions, and our execution has just been fantastic.

Jamere, I have a question for you on just product mix. You have a terrific private label brand. Over the course of the last 3 years, and in particular, maybe this year, can you discuss if there's been any sort of consumer preference or even professional preference towards sort of private label versus branded?

Yes. So we've invested in a meaningful way in our Duralast brand, which, quite frankly, calling it a private label brand or a house brand is a little bit of a misnomer. It's actually one of the strongest brands in the auto aftermarket. And we're pretty proud of that. It's backed by a very strong supply chain and supplier network. We think about the investments that we've made in our Duralast Gold and our Duralast Elite products, for example, which, in many instances, are actually better than the OEM quality products that are on the marketplace. So we've done that in a meaningful way, and we've done it over a number of years. And every time there was an opportunity, quite frankly, for us to go challenge what we were doing with some of our branded products, we've really pushed the envelope, if you will, working with our suppliers to find a way to make Duralast products that are of high quality, that are relevant and, quite frankly, give us an opportunity to control much more of our destiny in terms of our supply chain, our pricing and, certainly, our margin structure. So we feel very good about that. One of the places where we've made meaningful progress is particularly on the Do-It-For-Me or the commercial side of the business where we made meaningful investments in our Duralast brand, and that's actually helped us grow our business significantly on the commercial side of the business in addition to a number of other initiatives that we put in place.

Yes. And I do want to talk about the DIFM growth. But to touch on the supply chain that you talked about, I mean, we've had some supply chain issues. Can you kind of discuss where you think you are in that trend? And then also, does it impact your decision on to your sourcing or your private label business?

Yes. I mean, obviously, supply chains were challenged across all of the industry, and our industry certainly was not immune to those dynamics. We had a couple of things that worked in our favor, one of which is actually having the Duralast brand, which enabled us to move volume in some instances and some critical categories amongst suppliers. So when you have a reliance on a single brand, you don't have that flexibility, if you will, but we had an opportunity in many instances to move volume between suppliers who may, for any one of a number of reasons, had supply chain challenges, and that worked to our advantage. I think the second thing that we've done over time is we've continued to look to diversify that supply base and reduce our reliance in some instances on certain regions of the world, if you will. And we were already doing some of that work well ahead of the pandemic, and that certainly paid dividends for us. I'll say this, overall, I think our supply chain did a fantastic job certainly relative to what you saw in other parts of the economy, really managing their way through a very difficult environment that started with COVID and COVID lockdown, supply chain challenges coming out of Asia. You saw the shipping challenges. You saw material shortages in some places. Our suppliers did a really nice job of managing their way through that, and we certainly appreciate it. And our teams did a fantastic job as well. I mean, we -- our in-stock levels quite frankly were better than many of our competitors in the marketplace because of those efforts, and we were able to benefit in our business. And what I'll say is that things have gotten better -- significantly better. There are still some challenges in certain categories, but we have done just a tremendous job of working our way through a very challenging environment. Again, I tip my hat to the entire supply chain, including our suppliers and our folks internally and our merchandising and supply chain areas.

Perfect. And I think that touches on the Do-It-For-Me growth questions I have, just 27% in fiscal year 2022 is pretty impressive. It went from a business when I started to not being really how I thought of AutoZone, and now a big part of how I think of AutoZone. Can you just talk about what you've done over the last few years? Clearly, you have -- I'm assuming you've taken share. How have you taken that share? And is it sticky?

Yes. We've made significant investments in our Do-It-For-Me business over the last several years or so as part of our commercial acceleration initiatives inside the company. The first, and I mentioned it a little bit earlier, is the work that we've done to invest in the Duralast brand and the quality of the Duralast brand. That gave us an opportunity to go into shops and say, this is a brand that we stand behind. And not only will we make good on the product, but we'll also make good on labor associated with failures. And that gave shops a lot of confidence and willingness to go try our Duralast brand in a much more significant way. We've made significant investments in product assortments in our stores, including expansion of our Hubs and Mega-Hubs. This gave us an opportunity to put more parts in a marketplace closer to customers. And that's given us the ability to move up the call list in many instances and be able to fulfill in a significant way. We've invested in technology. We've put handheld technology in the hands of all of our drivers that enables a customer to do business with us in a much more efficient way than they had in the past. It's improved our delivery times. Our delivery times are probably down 15% or 20% since we invested in that technology. And that's been meaningful to our customers. And then the final one is that where we have significant price gaps, particularly relative to warehouse distributors, we've narrowed those in certain categories, in certain markets to make us more competitive. So there hasn't been one initiative, if you will. It's been a myriad of things that we've been working on, and those things have paid significant dividends for us. As you mentioned, we were up almost 27% on a -- from a growth standpoint last year. We've had 8 straight quarters of double-digit growth, 6 straight quarters of over 20% growth. And really, the future is very bright. I mean this is a business, quite frankly, where we're at 4% to 5% market share in what we believe is over $100 billion market. It's been very fragmented for a long time. And investments that we've made give us a lot of confidence and a lot of excitement about our ability to grow in a meaningful way going forward. And Brian and I were laughing coming on in our last earnings call, we finally got our Chairman and CEO, Bill Rhodes, to say, our aspirations are to be a leader -- be the leader not only in DIY, but also in commercial. And we were kicking each other under the table and high-fiving after the call because we really do believe we have an opportunity to do both, and we're pretty excited about the growth prospects going forward.

In order to earn that share on the Do-It-For-Me side, is there more investment that needs to take place from a human capital perspective? Or do you think that this is all growth from here, and therefore, very accretive from a margin and profit perspective?

Yes. And one of the things that really stands out to me, I've been at AutoZone for 2 years. And as I've spent time with our commercial teams and spent time in the marketplace and with our customers, really struck me just how much of a relationship business the commercial side of the business is. And several years ago, we made a significant investment in putting a professional sales force in the field to go drive our commercial business. In addition to that, because we operate out of our DIY infrastructure largely, as I mentioned, we have a commercial program in roughly 87% of the DIY stores that we have. We've put our store managers as part of the process, our district managers, our regional managers, infrastructure, all focused on significantly strengthening those relationships from a commercial standpoint. And if there was a place where I think over time, we had a competitive disadvantage, it was just the depth of some of the relationships for folks who had been in that part of the business in a much more significant way for a lot longer than we had. And so we've invested. So we have the infrastructure that we need to compete there. We're building those relationships. And one of the things that really stands out to me is if you can have strong relationships, you have the parts so that when a customer calls or does an electronic order, and you can say, yes, we have it, we can get it to you there in a relatively short period of time, and pricing is not a dissatisfier, then that's a formula for us to go win in the marketplace. And again, we put the numbers on the scoreboard recently to show that, that strategy is working for us.

Yes. And just you mentioned have the parts. We haven't really touched on the distribution of strategy that you've had over the last few years. Can you kind of discuss that? And are you at the point where you're competitive? Or I mean is there still a runway to go with really optimizing that distribution capacity?

Yes. I mean we believe we're competitive, but we also believe that we have significantly more opportunity in the marketplace. As I mentioned, we're somewhere between a 4% and 5% share today. There is an opportunity for us to grow that significantly. One of the key tenets of that strategy is to put more parts in the market closer to customers. We've talked about publicly our desire to expand our Hub and Mega-Hub footprint. So just a little bit of perspective that a typical satellite store will have somewhere around 25,000 SKUs in a satellite. We'll have 45,000 to 50,000 in our Hub, and we'll have 80,000 to 110,000 in a Mega-Hub. We finished last year with about 78 Mega-Hubs in the marketplace. We have aspirations to go to 200 Mega-Hubs. And we have a little under -- we had a little under 200 Hubs. We expect to have over 300 Hubs. So we'll have 500 large-box formats to help us. Now the beauty of those formats, 2 things. Number one is inside the 4 walls of our Hubs and Mega-Hubs, we see a tremendous lift both from the DIY side of the business, but also from the commercial side of the business. It's -- those big boxes become magnets for customers who see those formats and go, this is a box that is likely going to have the parts that I need for the job that I'm taking on. But the other big benefit is the lift to the entire network. So our Hubs and Mega-Hubs serve as a fulfillment source, an important fulfillment source for other satellite program or other satellite stores, if you will, in a marketplace. And so as we've expanded our footprint there, one of the things that we've been testing is this notion of can we have a more denser network, if you will, of large-box formats, particularly Mega-Hubs. And we tested that in several markets. And remarkably, for us, we've seen each of those boxes that we've jammed into the marketplace do well on a stand-alone basis and not cannibalize the existing infrastructure. That's given us a lot of confidence that we can put more of those in the marketplace and really drive our business. And so more parts in the market closer to customers gives us an opportunity to say yes and gives us an opportunity to move up the call list and service those customers in a meaningful way.

Yes. And those investments have been going on for a while. Yet, you still generate $4 billion in EBITDA and only CapEx of around $700 million. Is that still kind of a cash flow kind of view that we're going to look at?

Yes. I mean it's a very capital-efficient business. Even as we've talked about expanding our Hub and Mega-Hub footprint, we still are able to do that within the construct of our normal annual capital allocation plans, if you will. One of the things that you've seen from us last year as we announced that we're investing in a couple of new distribution centers and also improving some of our direct import distribution center capabilities, that will cause our CapEx to tick up a little bit this year and a little bit next year. But the long-term algorithm, if you will, has not changed. I mean we'll add, call it, 200 stores or so in the Americas for the next several years really as far as the eye can see just based on the growth that we see in the marketplace. We'll continue to build out this Hub and Mega-Hub network as part of that framework, if you will. We'll invest in our existing assets. We'll invest in our growth initiatives. And still, at the end of the day, generate a ton of free cash flow that enables us to continue to invest in growth and do a meaningful share buyback program, which has been very, very successful for us over the years.

And I did want to ask you that before we do have a few questions from the audience. Around 2.1x, maybe net debt-to-EBITDA have been following this company, it's generally around 2.5x. Has anything changed in terms of your thoughts there or higher interest rates?

Yes. I mean our long-term leverage target is still in the 2.5x area, if you will. As we went through the last couple of years with really accelerated growth, we generated a significant amount of excess cash, if you will, and we put that to work in terms of doing a much higher buyback. And we're still, call it, 4 ticks under our long-term leverage target. We'll continue to march towards that 2.5x area. We've been making sure that we do that in a very disciplined way, and we'll continue to do that as we go forward. The implication for that is if we can continue to grow our business the way that we have historically, generate a lot of cash, we'll be able to do some very shareholder-friendly actions over the next few years or so as we get back to that leverage target.

Great. Did I see some questions over here?

Sure.

Go ahead.

I want to follow up on the Do-It-For-Me initiatives. You kind of mentioned 4 drivers, the private label, supply chain, tech and pricing. I guess, across those 4, have you seen any competitive responses, whether it's the larger players investing in more tech that maybe you don't have yet or the smaller players leaning in price? I'm just curious you gained so much share. How has the market responded, large or small player, across those 4 initiatives?

Yes. I mean the market has been very rational. And again, all of the things that we've done across our business, including things like pricing and technology, et cetera, we've seen competitive responses, but none of them have really disrupted the marketplace. And more importantly, none of them have slowed down our momentum. So we've been executing very well in the space over time. And I think if I think about the Do-It-For-Me market, if you will, I think what we've offered in the marketplace, what we've -- the way that we've executed, the way that we've taken care of customers, added more parts to the marketplace, made it easier to do business with AutoZone. All those things are resonating really well with our customers. And again, it gives us a lot of confidence about where we are today and, more importantly, in the future.

Brian, did you have a question?

Yes. So just on the inflation, and I guess, a really a mechanical question. So everyone's talked about inflation at this conference. You mentioned it, AutoZone has managed the inflationary pressures extraordinarily well. As we look over the next several quarters, if we assume that the rate of inflation will slow, would you expect then that you would see some offset to that in unit demand or just inevitably that means sales growth for AutoZone slows as well?

Yes. I mean a couple of things. One is we're still in a pretty significant inflationary environment in the aftermarket. And one of the things that really stands out to us is if you look at sort of the underlying drivers of inflation, and it's probably true not only for our industry but for others, is at 3.5% unemployment and, call it, wage rates growing with a 5 handle, if you will, that's pretty sticky. And as a result of that, I mean, we're still seeing fairly significant inflation in the aftermarket. And we expect to see that dynamic probably continue for the next few quarters or so just given the environment that we're in. And that's one. I think the second thing is that with interest rates growing the way that they are and the notion that rates are going to continue to grow, that's going to continue to add cost pressures in the industry. But quite frankly, over time, we expect to see that roll its way in the product cost, whether it's because of the balance sheet pressures that suppliers are feeling or the much closer in, they're feeling pressures from things like their supply chain receivables programs, et cetera. So we expect to see inflation pretty high for at least the next few quarters or so. That being the case, I think as there are opportunities for deflation, you may see us not passing as much through from a pricing standpoint, but from a margin accretion standpoint, we should be in pretty good shape because the other thing about the auto aftermarket that has, again, been remarkably resilient is that coming out of periods where you've had even hyperinflation, you generally don't see prices coming back down. And so that deflation, if you will, will give us an opportunity to have some margin expansion opportunities at some point in the future as well.

Great. And I'm just going to ask one last one even though we have run up against time. The DIY business has had significant growth. There has been some commentary around some pressures on the more discretionary items. Have you seen that stabilize at all, especially as gas prices have come down from $5 to close to $3.80?

Yes. We're seeing DIY traffic really be stable. I mean, historically, you've seen on the DIY side, just because of changes in technology and SKUs and those sorts of things, you're typically seeing traffic on the DIY side be down in the low single-digit kind of declines. And we're seeing things stabilize in sort of that ZIP code, if you will. The consumer has been remarkably resilient. And again, part of that is, as I mentioned before, the relative inelasticity of demand. But consumers also walked into this cycle with a much better balance sheet and a much bigger safety net. And again, at 3.5% unemployment and 5.5% wage growth, it means that everybody is working and everybody is getting a raise, and that's a much bigger safety net than probably many people anticipated. So consumer has been resilient. We really haven't seen a wobble from the consumer at all.

Perfect. Well, thank you so much for being here. Thanks for going over time with us. And thank you for all...

All right. Thanks. Always good to see you guys.