O'Reilly Automotive, Inc. (ORLY) Earnings Call Transcript & Summary

All right. Great. So and next up, we have O'Reilly at nearly about $11 billion in revenue. They are our last presenting distributor, but definitely not our least, and definitely, a big part of what this aftermarket conference is about. The company is roughly about 50%, 50% do-it-yourself, do-it-for-me and sells through nearly 6,000 stores across the U.S. and they've entered Mexico, which we'll love to talk about. So 74 million shares at $450, market cap of $34 billion, net debt of $3.2 billion. Today, we have presenting CFO, Tom McFall; and Mark Merz. Guys, thank you so much for joining us today. We're so happy to have you again this year.

Thank for having us in this new format.

Yes, absolutely. We appreciate you inviting us.

Terrific. So I think we'll just start with general company question, kind of just discuss your store base and discuss your customer and kind of what's important to that customer.

Okay. So we're running over 5,000 stores. Mark could give you the exact number. It changes every day. We have multiple openings a week, and we've aggressively opened over the last 25 years to get to this number, started with 1 part store in Springfield, Missouri. When you look at our customer base, we implemented and became the first company to really run a dual market strategy in the aftermarket. Historically, companies had either focused on the professional business or on the do-it-yourself business. We [ had ] about 25 years ago, we opened our first dual market strategy store. Our background was in the professional business, and we added a sales floor to one of our stores here at Springville, Missouri and started really focusing on both sides of the business. So when we look at our professional business, they are the installers. They're the folks that are going to fix your cars if you're not going to go to the dealership to get your vehicle fixed. The professional installers started when vehicles became more popular and more popular and the OEs couldn't service all the vehicle fleet. Many of the professionals actually started in the dealerships. Dealership trained and went out on their own to start their own shops. Over time, many of the shops [ viewed ] -- shops started independent. And over time, they've grown into regional and a few national chains that do installation, running the gamut from basic repairs of tires and brakes to drivability and diagnostic repairs that require a lot of equipment. So on the other side of the dual market strategy is the do-it-yourself side of the business. So as vehicles became mass-produced and became affordable for the everyday American, thank you, Mr. Ford, vehicles were in the hands of people who demographically couldn't afford to have someone do the repair. The do-it-yourself aftermarket was born, and these are people primarily that are repairing their vehicles out of economic need. And our job is to provide the parts for those folks that -- and the testing equipment, the motor tools and really the expertise to help them do the repair. When we look at the market in general, the 2 things our customers are looking for are the parts they need to fix their vehicles right now. In the professional side of the business, they're expecting delivery of the parts to finish the job in 30 minutes. And how that works is, they get the car on the hoist or on the rack, as we would call it in the industry, and they get the wheels off and diagnose the problem. The customers told them what they think the problem is, but the mechanic is going to then diagnose it, the technician will diagnose it. They'll come up with a quote and hopefully, the customer will say, yes, let's go ahead and do that repair. And they will order the parts. The faster they can get the parts, the faster the technician can get the car repaired, get it off the hoist, get paid, have a happy customer and start the process again. So having parts close to the customer on the commercial side of the business is critical, and that's always been the case. As a result, in aggregate, for the automotive aftermarket, we've always had a very robust distribution model with many, many parts locally available, primarily based on the number of vehicles that were manufactured. So every [ Italian bird ] in the United States has brake pads for a Ford F-150. Now every time a [ bird ] might not have one for a BMW 750, that's more -- less run, more specialized. On the -- so the backbone has been that driver to get the shops what they need so they can run their business. On the DIY side, similar issue is I don't have an extra car. I am using this for my daily commuter. Our customers -- in general, we don't sell very many dress up or accessory parts or performance parts. We do, but not a lot. That was a great catalog business, and that was a great online business. Our specialty is in the maintenance and repair parts. Folks need to keep their cars on the road. So I'm a DIYer, I really don't want to get a new set of spark plugs. But when my car starts misfiring, and I've got a plug or a wire out and I've got to fix it, I've got to fix it today. I don't have an extra car. I got to commute to work tomorrow or I've got my kid's soccer game tomorrow, I got to get it fixed. And I want to come in find a OE form, fit and function part at a reasonable price.

Okay. So that's great detail. One thing you touched on was they need that part.

I'm going to see how many times I can sip out of my coffee cup. You like it?

I'll ask in marketing there.

I also noticed the decorations in the background, Tom. I don't know if you would have had that camera focused if not for this past weekend either.

It was a surprising victory. For anybody who is on here from Michigan State, Go Green. For anybody from the University of Michigan, I was pretty shocked and was just curious if you were.

No dog in the fight. Congratulations.

Thanks.

I don't know what the fight is about. Okay. So into the do it -- I mean when you talk well the immediacy of that need, what your customer wants, you have a pretty expansive distribution system. Can you just talk about that, the different aspects of it and how it serves that customer and creates a barrier to entry?

So as we talked about, the availability of product is the #1 determinant. Can't sell from an empty shelf. People are trying to fix their cars right now. So we've always run a very distribution-intensive model. And we have a very flexible system. Obviously, you want to have the part in the store to sell right then and there. With the growth of the number of vehicles on the road, with the age as OEs have built better vehicles that stay on the road longer, as the OEs have designed vehicles to be part specific as they attempt to reduce the weight and improve gas mileage inefficiency and with the entry of Asian and European nameplates into the market, there are tremendous amount of vehicles out there, millions of parts. So we use a proprietary system that looks at the demographics of each individual store. And each individual store has their own set. And they may have 20,000 to 27,000 different parts in the store depending on the store that they're in. But there's millions of parts available. So what do you do when a customer calls and wants to find a part you don't have in the store, you're out of stock of? So the way we distribute is we work on breadth, not depth, of the product and then support it with our robust distribution network. And it's very flexible. Stores could get parts in a number of different ways. They -- there's the average store. The next step up would be different layers of hub stores that may carry 40,000 to 100,000 SKUs. And they'll run daily routes to the surrounding stores 4 to 6x. Then on top of that is our distribution -- our regional distribution centers. We have 28 currently that stock anywhere from 120,000 to 200,000 SKUs. They will deliver nightly to all the stores they service. And for stores in their metro markets, they will deliver 4 to 8x a day special orders. When we look at how much service the store has and how many times we touch that store on a daily and weekly basis, we can adjust that. We can open hub stores, sometimes we open them, sometimes we close them, sometimes we consolidate them, sometimes we increase the frequency of routes. We will gear up our distribution to have the best availability in all the markets we serve.

Perfect. And I mean, clearly, you guys have done an outstanding job in that. If I look at my estimated 2020 earnings, you've done about a 5-year earnings CAGR of 20%. So very impressive. Can you just talk about financial model there from what you've spoken about already, but down to the bottom line?

Sure. So not surprising, gaining market share and retaining market share, growing in new markets and existing markets is about having inventory [ brake ] distribution locally available and then having the best teams. And we have always focused on a customer service culture from the days that the 13 team members started O'Reilly Auto Parts here in Springfield, and it's our mantra. We are a very promote-from-within company, very store operations focused. So the majority of our leadership has been in the auto parts industry for decades and many, many of us started pushing brooms and worked our way up through the stores. So that culture of service and mentor leadership and promote from within and taking the best parts person and making them store manager and then replicating their abilities and success and the folks that work for them. And then district manager, region manager, vice president, the same thing. That, that for us has been critical because we run a technical business. It is -- it takes a while. It takes 2, 3 years on the counter to become proficient. So we want to have people that are mechanically inclined and service-oriented and promote those folks and have them over a larger span where they can mentor and develop people with a similar skill set.

Okay. And then I'm just going to ask a question from the audience. Sorry. I have 3, I'll do 2 first. When you talk about having parts ready at a reasonable price, can you just talk about that price in the industry? And kind of what justifies your 19% margin given the rest of the retail industry, which is probably significantly lower than that?

A fine question. So when we look at pricing, we're going to price at good, better, best. Good products meet OE specs, all the way up to the professional grade that installers are going to put on because they pass that price through. And their emphasis is ongoing above and beyond and not having warranty work and have issues come back, so they're willing to pay more. But we obviously have a high gross margin in our industry, high operating profit. But if you look, we also have a tremendous amount of inventory in assets, right, that we need to make return on with super slow churn in our inventory, and it gets back to that. The most important thing is immediacy of need, having the parts, having them locally and available. As a result, you end up with a lot of brick-and-mortar, end up with a lot of distribution and you end up with an inventory turn that's below 1.5. So when you look at the GMROI in our business, it's not dissimilar from other retailers. When we talk about what makes our model work, it's investing that capital to be able to provide the value customers are looking for, go out hustling every day to grow market share. It's about using our scale to buy well and stocking the parts that our customers want, whether it's brand names that installers have preferred and do training and our backbone of our professional business or house brands that we have developed that are great -- that really go across the value spectrum, good, better, best. And when we can control our own brands, we can control the price, we control what's in the box, we can use multiple suppliers that, that -- because we're looking at -- if you look at brakes, you're looking at American-made cars, European, Asian, and all the suppliers don't fit that cross section very well. So using different suppliers can be very helpful and helping them reduce their cost to us because they make what they're good at. And then it gets down to grinding away on expenses. We are a very expense control company. It's always been -- it's actually culture values, which I like as a CFO. So when we talk about reducing expenses, and when we see other people in other industries talk about, they're going to reduce their non-customer-facing expenses, I don't know about Mark, we scratch our head and we say, why do they have them if they're not providing value to start with.

I felt that. That's great. I mean, like I said, 5-year earnings CAGR of 20% is pretty impressive. But what else is impressive is a 16.9% comp on top of your 16% comp last quarter. Just very exceptional, especially in lieu of the fact that it looked like miles driven probably averaged down 10% last quarter. Can you kind of talk about the drivers of this growth in response to COVID, categories that did well? And what you think we'll be seeing going forward?

Okay. Well, I'll do my best on that. So 16.9% is a big, big number, and it's quite surprising. Obviously, we've talked about it at the end of March and beginning of April when COVID pandemic really started, and people were very unsure what's going on, our sales were down low single -- or low double digits. And we really looked at liquidity and making sure that we have the staffing dialed in for that to weather that storm. And lo and behold, some more was known about COVID. The government sent out stimulus checks, unemployment benefits were bumped up and people were at home with time on their hands, and I think that people took on additional projects. And similar to other DIY businesses, we saw business turn around in a hurry.

The color I would add to your comments is in aggregate, miles driven are the long-term driver of our business. The more people drive their cars, the more parts wear, the more maintenance you have to do, it drives demand. But what we would really like to see if we could dissect and [ turn it around ] statistic would be miles driven on cars outside of warranty. Cars that are inside of warranty, you're still doing regular maintenance, but anything that's failure related or really parts related isn't covered or is -- I'm sorry, it isn't those items that's covered. So if your water pump goes out in 3 years, you're going to go back to the dealer, and they're going to fix it. If your water pump goes out in 7 years, which is the average, then you're going to come to O'Reilly, and we're going to sell you a remanufactured water pump that's got a new bearing in it, and it's going to be -- run like [ it has ]. So with new car sales being down, we know miles driven on cars outside of warranty aren't down as much. The other thing we would tell you is that within our industry, and not surprising, is there is a tremendous amount of maintenance that is either underperformed or unperformed. Trying to get your arms around exactly what that number is, but our industry says it's about $50 billion. So fluctuations in how people look at their vehicles vis-à-vis, am I going to get in a new vehicle next month? Or do I need to fix the one I have now? When we go into recessionary or tough economic times, people say to themselves, gosh, I might keep this car for a while. I better maintain it. Or people who buy a new, a new to them car -- used car, will we do additional work to it. And when you look at the price of used cars, which have skyrocketed, people are holding off and they're valuing their existing car more, which means they're doing more maintenance, less reduced, less underperformed or unperformed maintenance, and that's a big support for our industry. When we look at categories, I think we've gotten a little bit off here. All the categories did well or we wouldn't have put up such a big comp. Unusual for this tough economic time versus 2008 is discretionary categories, wash, wax, appearance, some dress up, are doing better, which is hot. And when people don't have money and then times are tough, those go down. But in this particular case, they're actually outperforming base categories because people have time in their hands and there's been extra money put into the people's hands from the government. So people are doing those projects.

Perfect. And then what about -- is there any structural change you think that may have occurred in how you do business first, but then second, also any structural shift, I guess, on the long-term fundamental growth drivers?