A company selling aftermarket automotive parts may not initially seem like the most exciting investment. However, the automotive aftermarket industry is stable, with strong and consistent drivers of demand. O'Reilly Automotive is one of the best companies in this sector, having delivered outstanding results for its shareholders. The critical question is whether now is the right time to invest in O'Reilly Automotive. This analysis aims to investigate this question in detail.
This is not a financial advice. I am not a financial advisor and I only do these posts in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.
Since I have attended the workshop with Phil Town, I have decided to change the layout of my analyses a bit. I will do some more calculations and also briefly go through why the company has meaning to me. If you want to read more about how I evaluate a company, please go to "MY STRATEGY" on my website.
For full disclosure, I should start by mentioning that at the time of writing this analysis, I do not own any shares in O'Reilly Automotive. If you would like to see the stocks in my portfolio or copy my portfolio, you can do so on eToro, You can find instructions on how to do this here. I don't own any stocks in competitors of O'Reilly Automotive either. Thus, I have no personal stake in O'Reilly Automotive. If you want to purchase shares (or fractional shares) of O'Reilly Automotive, you can do so through eToro. eToro is a highly user-friendly platform that allows you to get started with investing with as little as $100.
The Business
O'Reilly Automotive was founded in 1957 in Missouri, United States. The company operates as a retailer and supplier of automotive aftermarket parts, tools, supplies, equipment, and accessories in the United States, Puerto Rico, Mexico, and Canada. O'Reilly Automotive provides a wide range of products, including new and remanufactured automotive hard parts and maintenance items such as alternators, batteries, brake system components, belts, chassis parts, driveline parts, engine parts, fuel pumps, hoses, starters, temperature control, water pumps, antifreeze, appearance products, engine additives, filters, fluids, lighting, oil, wiper blades, and accessories like floor mats, seat covers, and truck accessories. Its stores also offer various services, such as battery diagnostic testing, battery replacement, wiper replacement, and bulb replacement. In 2023, O'Reilly Automotive derived approximately 53% of its sales from DIY customers and about 47% from professional service provider customers. Historically, O'Reilly Automotive has increased its sales to professional service provider customers at a faster pace than to DIY customers due to the more fragmented nature of the professional service provider business. Consequently, the professional service provider business is poised to become the company's largest segment. By the end of 2023, O'Reilly Automotive operated 6.092 stores in the United States, three in Puerto Rico, and 62 in Mexico. In January 2024, O'Reilly Automotive expanded its business into Canada by acquiring Groupe Del Vasto and its 23 stores. As one of the largest companies in the industry, O'Reilly Automotive's scale provides a moat. This scale allows the company to offer more stock-keeping units than most competitors and to sell them at lower prices, leveraging its ability to negotiate better terms with suppliers.
Management
Brad Beckham is the CEO of O'Reilly Automotive. He joined the company in 1996 as a Parts Specialist at the age of 17, a role that initially involved sweeping floors and organizing stock. Over the years, Beckham advanced through various positions within the company, including Store Manager, District Manager, Region Manager, Divisional Vice President, Vice President of Eastern Store Operations and Sales, Senior Vice President of Central Store Operations and Sales, Executive Vice President of Store Operations and Sales, Executive Vice President and Chief Operating Officer, and Co-President. He became the CEO in January 2024. Although Beckham is new to the CEO position, he brings extensive experience from his various roles at O'Reilly Automotive, which will be highly beneficial in his leadership. Brad Beckham is only the fourth CEO in the company's history, and his promotion reflects O'Reilly Automotive's culture of promoting from within. Despite not having a college degree, Brad Beckham's deep understanding of the company and the industry, honed over nearly three decades, provides him with unique insights that cannot be easily taught. Brad Beckham is known for his ability to identify competitors that would be an excellent fit for the company through acquisitions and for his adaptability to adversity. As CEO, he has expressed his focus on gaining market share, ensuring profitability, and driving operating profit dollar growth—strategies that should benefit investors. While Beckham is still new in his role as CEO and cannot yet be judged on his results in this position, his comprehensive experience across all facets of the business instills confidence in his leadership. I believe that his deep knowledge of the company and the industry will serve O'Reilly Automotive well in the future.
The Numbers
The first metric to investigate is the return on invested capital (ROIC). Ideally, we seek 10 years of historical data with ROIC exceeding 10% across all benchmarks. O'Reilly Automotive has demonstrated a strong competitive moat over the past decade, consistently delivering a high ROIC. For the past ten years, O'Reilly Automotive's ROIC has remained above 20%, and since 2017, it has exceeded 30% annually. Remarkably, in the past three years, the company has achieved a ROIC above 50% each year, further increasing to over 60% in the past two years. Such a consistently high ROIC is rare, and O'Reilly Automotive's ability to increase it in most years is particularly encouraging. I have a strong preference for companies that consistently deliver a high ROIC, and O'Reilly Automotive clearly fits into this category.
The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most important of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actual numbers and the percentage growth year over year. At first glance, these numbers may not seem encouraging, as equity has decreased year over year in eight of the past ten years. Additionally, equity has been negative for the past three years. This decline is primarily due to O'Reilly Automotive's strategy of using debt to buy back shares, which explains the observed figures. Over the past decade, many companies have used inexpensive debt to repurchase shares, which can be an effective way to return value to shareholders. However, as debt becomes more expensive, this strategy is less appealing. Although O'Reilly Automotive's approach has contributed to the decline in equity, it is crucial to consider the broader context and the company's overall financial health.
Finally, we will analyze the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. I use levered free cash flow margin because I believe that margins provide a better understanding of the numbers. Free cash flow yield refers to the amount of free cash flow per share that a company is expected to generate in relation to its market value per share. It is not surprising that O'Reilly Automotive has delivered positive free cash flow every year over the past decade. Free cash flow reached new record heights in the past four years but experienced a decrease in 2023. This decrease is attributed to increased capital expenditures as management has invested in driving long-term growth. This trend is expected to continue in 2024, with management projecting free cash flow to remain at the same level as in 2023. The levered free cash flow margin remains high for the industry but also decreased in 2023, which has been a challenging year for most companies due to macroeconomic factors. The free cash flow yield is currently below the ten-year average, indicating that O'Reilly Automotive shares are not trading at a discount. This aspect will be revisited later in the analysis.
Debt
Another important aspect to investigate is the level of debt, specifically whether a business has manageable debt that can be paid off within a period of three years. This is assessed by dividing the total long-term debt by earnings. Upon calculating this ratio for O'Reilly Automotive, it is evident that the company has 2,37 years of earnings in debt. This is below the three-year threshold, indicating that debt is not a concern when considering an investment in O'Reilly Automotive. The relatively low level of debt is impressive, given that O'Reilly Automotive has used debt to buy back shares, reducing the number of shares outstanding from 101,4 million in 2014 to 58,9 million in 2023. This strategic use of debt to repurchase shares demonstrates the company's effective capital management while maintaining a manageable debt level.
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Risks
Based on my findings so far, O'Reilly Automotive appears to be a very intriguing investment. However, all investments come with risks, and O'Reilly Automotive is no exception. One significant risk is competition. The sale of automotive aftermarket items is highly competitive. O'Reilly Automotive competes with national retail and wholesale automotive parts chains such as AutoZone, Advance Auto Parts, CARQUEST, and NAPA, as well as regional retail and wholesale automotive parts chains, wholesalers or jobber stores, automobile dealers, mass merchandisers, and online retailers like Walmart and Amazon. Online retailers, in particular, pose a substantial risk as online sales of auto parts are expected to triple in the next decade. Although O'Reilly Automotive has invested in its online store to capitalize on this shift, this might not be sufficient. Online retailers are increasingly entering the auto parts market and capturing market share. For instance, Amazon's market share in the auto parts retail sector has grown significantly, from 7% in 2019 to over 12% currently. Management has highlighted that independent competitors are among the toughest for O'Reilly Automotive, as these competitors are incredibly well-run and hold a significant portion of the market share. This competitive landscape underscores the importance of strategic planning and continuous innovation for O'Reilly Automotive to maintain and grow its market position.
Macroeconomic Factors. O'Reilly Automotive has noted that although the demand for many of their products is primarily non-discretionary and driven by necessity, their sales are still impacted by the economic health of their customers. Customers' purchases, including those of O'Reilly Automotive products, can decline during periods of lower income, rising prices, or in times of actual or perceived unfavorable economic conditions. Management has expressed caution in their outlook regarding the potential for worsening economic conditions or short-term economic shocks. They are particularly concerned about the impacts of sustained higher price levels and interest rates, spikes in gas prices, or election year volatility. These macroeconomic factors could negatively affect consumer spending and, consequently, O'Reilly Automotive's sales.
Transition to Electric Vehicles: The increasing prevalence of electric vehicles (EVs) presents another risk for O'Reilly Automotive. Analysts project that the market size for electric vehicles will be nearly ten times higher by 2033 compared to current levels. The components for traditional gas-powered vehicles differ significantly from those required for EVs. While parts such as tires, windshield wipers, brake pads, and mirrors are necessary for all types of vehicles, many components specific to gas-powered cars, like filters and pumps, are not needed in EVs. Electric vehicles generally have fewer parts, leading to lower ongoing maintenance costs. The impact of the transition to electric vehicles on O'Reilly Automotive is uncertain. However, in its annual report, O'Reilly Automotive notes that this shift may result in less frequent repairs, longer-lasting parts, or the elimination of certain repairs altogether. Consequently, the transition to electric vehicles could potentially affect O'Reilly Automotive's long-term business prospects.
Reasons to invest
One compelling reason to invest in O'Reilly Automotive is its operation within an attractive industry. Management has indicated that the fundamental backdrop for the automotive aftermarket industry is stable, with strong demand drivers. The daily transportation needs of consumers generate robust and resilient demand for the industry, presenting a compelling value proposition for consumers to invest in the repair and maintenance of their existing vehicles. The demand for products sold in the automotive aftermarket is influenced by factors such as the total number of vehicle miles driven, the total number of registered vehicles, and the age and quality of these registered vehicles. Management has observed continued improvement in the total miles driven in the U.S. over the last several quarters and expects steady growth in this metric, in line with long-term industry trends driven by population growth and an increase in the size of the car park. Additionally, the industry has benefited and is expected to continue benefiting from the increasing average age of vehicles. Consumers are showing a strong willingness to prioritize investments in their existing vehicles to keep them on the road longer at higher mileages. This trend supports sustained demand for automotive aftermarket products and services, further enhancing the attractiveness of O'Reilly Automotive as an investment.
New Stores: One of O'Reilly Automotive's growth strategies is the aggressive opening of new stores. In 2023, O'Reilly Automotive opened 166 new domestic stores and 20 new stores in Mexico. Management has expressed satisfaction with the performance of these new stores and excitement about growth opportunities in both new and existing markets. They plan to continue opening new stores that generate higher sales volumes and stronger cash flows, driving enhanced returns on capital invested. Management's optimism is well-founded. On average, a new store costs between $3 million and $3,3 million to establish, while the average O'Reilly store generates $2,6 million in annual sales. This is significantly higher compared to the average auto parts store in America, which generates around $1,5 million in annual sales. Furthermore, O'Reilly stores benefit from the company's scale and operational efficiency, resulting in higher margins compared to many competitors.
Acquisitions: Another growth strategy for O'Reilly Automotive is through acquisitions. The automotive aftermarket industry is still highly fragmented, and management believes that national auto parts chains like O’Reilly can operate more efficiently and effectively than smaller independent operators, leading to continued industry consolidation. O'Reilly Automotive intends to selectively pursue strategic acquisitions that will strengthen its position as a leading automotive aftermarket parts supplier in existing markets and provide a foundation for expansion into new domestic and international markets. For instance, O'Reilly Automotive recently acquired Groupe Del Vasto, marking their entry into the Canadian market. Management has indicated that this acquisition will provide a strong foundation for growth in Canada and views it as a critical component of their strategic expansion plans. Historically, O'Reilly Automotive has made acquisitions approximately every two to three years, typically to expand into new areas. Therefore, we are likely to see more acquisitions in the future, supporting the company's growth strategy.
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Valuation
Now it is time to calculate the share price. I perform three different calculations that I learned at a Phil Town seminar. If you want to make the calculations yourself for this or other stocks, you can do so through the tools page on my website, where you have access to all three calculators.
The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. I chose to use an EPS of 38,47, which is from the year 2023. I have selected a projected future EPS growth rate of 7%. Finbox expects EPS to grow by 6,6% in the next five years. Additionally, I have selected a projected future P/E ratio of 14, which is double the growth rate. This decision is based on O'Reilly Automotive's historically higher price-to-earnings (P/E) ratio. Finally, our minimum acceptable rate of return has already been established at 15%. After performing the calculations, we determined the sticker price (also known as fair value or intrinsic value) to be $261,88. We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy O'Reilly Automotive at a price of $130,94 (or lower, obviously) if we use the Margin of Safety price.
The second calculation is known as the Ten Cap price. The rate of return that a company owner (or stockholder) receives on the purchase price of the company essentially represents its return on investment. The minimum annual return should be at least 10%, which I calculate as follows: The operating cash flow last year was 3.025, and capital expenditures were 1.032. I attempted to analyze their annual report to calculate the percentage of capital expenditures allocated to maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated to maintenance purposes. This means that we will use 722 in our calculations. The tax provision was 651. We have 58,982 outstanding shares. Hence, the calculation will be as follows: (3.025 – 722 + 651) / 58,982 x 10 = $500,83 in Ten Cap price.
The final calculation is referred to as the Payback Time price. It is a calculation based on the free cash flow per share. With O'Reilly Automotive's free cash flow per share at $34,28 and a growth rate of 7%, if you want to recoup your investment in 8 years, the Payback Time price is $376,33.
Conclusion
I believe that O'Reilly Automotive is an intriguing company. The CEO, while new to his role, has extensive experience within the company, having worked his way up through various positions. I value this type of leadership as it provides unparalleled understanding of the company and the industry. Therefore, I am not concerned about the CEO's recent appointment. O'Reilly Automotive has consistently delivered a high return on invested capital (ROIC), reaching new heights in the past three years, which is a significant positive indicator. Although free cash flow has decreased slightly, this is due to higher capital expenditures as management invests in long-term growth. The company operates in a highly competitive and fragmented market, facing competition from various entities, including national retail chains, regional chains, and online retailers like Amazon. While O'Reilly benefits from its scale, it is important to monitor how the market develops, particularly as online retailers gain market share. O'Reilly Automotive also faces macroeconomic headwinds, but these risks are likely short-term as economic conditions will eventually improve. The transition to electric vehicles could potentially affect O'Reilly Automotive's long-term business prospects, necessitating close monitoring of how the company adapts to this trend. However, this transition will take time, and in the interim, O'Reilly operates in a compelling industry with stable growth. The company's ongoing store openings, which are more profitable than the average auto parts store, should result in higher sales volumes and stronger cash flows, driving enhanced returns on capital invested. Additionally, O'Reilly Automotive has a successful track record with acquisitions, recently entering the Canadian market through its acquisition of Groupe Del Vasto. Future acquisitions could further boost growth by facilitating entry into new markets. Overall, I find O'Reilly Automotive to be a compelling investment. However, due to the risks associated with competition and the transition to electric vehicles, I prefer a discount before purchasing shares. Therefore, I will only buy shares if they drop to $800, which would provide a 20% discount on the intrinsic value based on the Ten Cap price.
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