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Why do AutoZone and O'Reilly have such high margins for a retailer?


LongHaul
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Why do AutoZone and O'Reilly have such high margins for a retailer?

 

If someone said in 2009 that AutoZone would have ~19% EBIT margins, I would have doubted it as I would have though they would come down to a more normalized level.  O'Reilly also has ~17.6% now as ORLY GM have increased almost 8% since 2005. 

 

Seems like it is a consolidated industry where AZO and ORLY have increased prices substantially and kept them high without consequences so far. 

 

Any insight appreciated.  Thanks in advance.

 

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My guess is that there's a disconnect between product and customer.  The customer being the driver.  The average drive doesn't have a good grasp for the price of say a timing belt.  If it breaks, they take it to a mechanic and get it fix.  The mechanic runs down to AutoZone or O'Rielly, buys the part, and fix the car.  The customer pays for both the part and labor.  As long as the car is fix then the extra premium paid is worth the convenience.

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I've heard the FPA guys talk about ORLY a lot. I think they have the same take on it.

Availability, delivery and network scale to provide immediately needed parts is the key.

End customer doesn't get to price shop when mechanic buys it for them. Cost gets

past through to customer. Mechanic needs to know they are going to get the parts fast.

 

 

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I have always been surprised by the number of O'Rielly (and previously Shucks) stores in Seattle but the more I think about it, it makes sense. I have not needed an auto parts store for a long time but if I think back to when I was keeping my older vehicles on the road earlier in life it makes sense. Every time I have gone to an auto parts store I needed something quickly and I always go to whatever is closest to my house. I am most concerned that the part is available now to fix my vehicle so I can get back on the road. I am not going to nickel and dime, wasting a few hours in the process. The only time I would go to another store is if the part is not in stock.

 

I don't if the same goes for independent repair shops or not. I feel like most of the independents I have gone to deal with NAPA which tends to be more focused on repair shops, although they do sell retail as well. I know NAPA does delivery and net terms, do Orielly and AZ do that as well?

 

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One key distinction for the auto parts retailers is that they are basically convenience stores. Their top selling products every month are usually motor oil, fluids and car batteries, all high margin products that people purchase out of necessity based on the location of the nearest retailer. Autozone in particular has their branded battery line, Duralast.

 

The most impressive thing about these retailers though is their cash conversion cycle. Their payables terms sometimes extend past 365 DAYS and average over 100!

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Here is some commentary from a couple years ago about ORLY strategy from a while ago.

ORLY was their largest holding in 2 funds for quite some time. FPA knows it well.

 

O’Reilly Automotive. For the past few decades O’Reilly has followed the same simple, straight-forward business plan – use all cash flow to expand the store base incrementally from its Springfield, Missouri headquarters, supplemented by infrequent opportunistic acquisitions.

O’Reilly has successfully followed that strategy while growing from its original single store in southwest Missouri to the current 4,000 stores, covering most of the country.

As it starts to fill-in the parts of New England and Florida where it currently is unrepresented, O’Reilly is making some changes to how it allocates its cash flow to reflect its reduced internal reinvestment opportunities.

These changes include:

 Slowing store growth

 Negotiating changes in terms with suppliers to increase cash flow by slowing payments for goods

 Modestly increasing leverage

 Using free cash flow to repurchase shares

Interestingly, this strategy has been followed to great success by Auto Zone, the #1 auto parts retailer, over the past decade. The impetus was similar – running out of attractive new store locations.

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I think they're really more distributor than convenience store.

 

In part, margins need to be higher because turns are much lower than your average retailer. That said, the industry has found a way for suppliers to finance the inventory, and hence ROA is sky-high. It's impressive.

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Availability, delivery and network scale to provide immediately needed parts is the key.

End customer doesn't get to price shop when mechanic buys it for them. Cost gets

past through to customer. Mechanic needs to know they are going to get the parts fast.

 

This is how I understand it. They encircle a desired area so that they are the most convenient/reliable supplier to small collision shops. Since the customer of collision shops generally wants their car fixed fast (and cost of parts are generally a small % of the total repair cost), the collision shops end up sourcing all of the parts through O'Reily or Autozone. Consolidation has certainly occurred over the last 10-20 years and these two are generally the only secondary parts suppliers in any region they are in (which provides some pricing power because customers will pay a premium to save time). The major oil companies or part manufacturers have always tried to consolidate their customer relationships because their biggest challenge is inventory management. Thus, they are willing to finance ORLY/AZO  as a trade-off for increase inventory certainty.

 

I really can't think of a way to break the system as it currently stands since future secondary-parts stores earn pathetic margins because they aren't big enough to be financed by suppliers. The suppliers don't want to distrupt the current system because they earn higher margins (even with lower effective sales prices) due to better inventory management (and it's extremely expensive to experiment with new systems). Finally, collision shops would need to go through a considerable consolidation process before their negotiating power is large enough to lower parts prices (which they probably don't even care to lower since it's almost always directly passed through to the customer). Very few customers plan to repair their car ahead of time so time will always be the prevailing issue. Great businesses!

 

As a side note, what are the major influences on revenue fluctuations? Is it new cars sold or gas prices? What can cause an ~10% drop in revenue assuming the current supply chain above is intact?

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All of this was true 10-15 years ago except the industry is more consolidated now.  AZO, ORLY and AAP being the biggest players.

 

There are really 2 sides - commercial (DIFM) and DIY.  If I am an independent auto repair shop working on someone's car I ultimately pay the price from the commercial seller so I care a great deal about getting the best price especially because I am buying tens of thousands of dollars a year and my business is tough already. 

 

On the retail side AZO is a huge player.  Keep in mind a lot of people fixing their cars are price sensitive.  They don't make much money.  Not sure how much is convenience vs price.  Same was true 10 yrs ago yet margins are much higher.

 

The margins on low moving inventory is insane.  Well over 50% Gross Margin.  Amazon and the internet offer huge discounts to those willing to wait a little and this channel is growing quickly.  A lot of stuff is half off depending on the part.  See this site for parts comparison shopping:  http://frugalmechanic.com/

 

With the A/P being pushed out by AZO, ORLY.  It is effectively a price decrease to their suppliers that does not show up in AZO's GM's.  So I would argue that their true GM over the last 10 -15 yrs has actually gone up if one adjusted for this.

 

I think it is really some type of tacit collusion where they are consolidated and pushing up prices to what they can get away with.  I think eventually supply will come on to bring returns on capital down but not sure of the catalyst besides the internet.

 

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The margins on low moving inventory is insane.  Well over 50% Gross Margin. 

 

Anther parallel can be found in FAST gross margin, way above distributors of other products.  10 points higher even compared with thier peer like a GWW.  But GWW turns over their inventory more than FAST, all in a significantly less consolidated space.

 

Convenience, a locked in client base, availability.... 

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Another good example is APH - Amphenol which sells connectors for sensitive technology. Customers are willing to pay for premium quality and ROIC is 20%+ last I checked.

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  • 1 year later...

How do we think about the electric cars potential impact to the aftermarket auto parts business? Typical E-cars only need 1/3 of parts of traditional cars. E-car does not have engine, transmission, no need to change oil or filter, much less maintenance...

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How do we think about the electric cars potential impact to the aftermarket auto parts business? Typical E-cars only need 1/3 of parts of traditional cars. E-car does not have engine, transmission, no need to change oil or filter, much less maintenance...

 

Would need significant evidence of e car adoption and then there is run off of current as vehicles. Looks probably be quite a ways off at this point.

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Looks like Amazon thinks the auto parts market is ripe for disruption.

 

http://www.cnbc.com/2016/09/21/amazon-to-disrupt-auto-parts-industry-jefferies.html

 

I don't see how Amazon gets past the "I need it right now" problem. Typically when people need a new car battery, spark plugs, etc they need it immediately, making even one or two day shipping too slow. Even something like motor oil, which may not be needed immediately, seems like a poor candidate for online shopping due to weight and possible hazardous nature.

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