This Company Is a Mechanic's Best Friend

This Company Is a Mechanic's Best Friend

If you are a mechanic under time pressure to complete an assignment for your client, you will waste no time in going to the retailer with the widest availability of hard-to-find auto parts. O'Reilly Automotive , a leading U.S. retailer of automotive aftermarket parts, is often the first port of call for professionals.

Customer mix is the base for success
O'Reilly's customer mix is unique, with an almost equal focus on both DIY customers and professionals such as auto repair shops. It generated approximately 59% of its fiscal 2012 revenues from DIY customers, and 41% from professional service provider customers. There is a positive spillover effect as its DIY customers benefit from the high service standards demanded by the professionals.

Professionals such as mechanics work on tight customer schedules, so the availability of parts is a key factor in their purchasing decisions. To ensure that most products are either in stock or available within a day, O'Reilly has an extensive distribution infrastructure in place, comprising 24 distribution centers. To put it in perspective, O'Reilly's distribution centers stock an average of 142,000 stock-keeping units, or SKUs, servicing its 4,000 stores a minimum of five times per week. This also has enabled O'Reilly to increase its store productivity, given that fewer inventories need to be stored at the individual stores. Instead, it works more like a "just-in-time" distribution system.

Counter-cyclical business
Investors in automotive aftermarket parts retailers like O'Reilly are able to avoid the cyclicality traditionally associated with the automotive industry. For example, new car sales are highly correlated with the economy's performance and consumer sentiment, unlike the aftermarket. When times are tough, people tend to hold off on new car purchases, which boost sales of automotive parts for old cars.

Furthermore, the mid-to-long-term prospects of the aftermarket parts industry remain bright. The average age of all U.S. light vehicles registered is now at a new high of 11.4 years old, compared with an average vehicle age of 9.8 years old. Technological advances have extended the "useful lives" of cars, bringing more business to companies such as O'Reilly.

The strong get stronger
While it does not take a lot of capital or skill for an individual to start a business selling auto parts, this entrepreneur faces mounting challenges in terms of inventory management and working capital funding when opening more shops. This is where scale matters, which favors the big boys like O'Reilly.

The numbers speak for themselves, with the industry exhibiting signs of consolidation historically. The top 10 auto parts chains currently account for 48% of market share, in terms of the number of shops, representing a huge jump from 31% in 2012 a decade ago. O'Reilly itself became one of the top three auto parts chains in 2008, following the acquisition of CSK Auto in 2008. In December 2012, O'Reilly acquired VIP, a private auto parts chain in New England, to expand into the Northeast. There are ample opportunities for O'Reilly to acquire more independent auto parts operators.

Future outlook
O'Reilly delivered an excellent set of results for the second quarter of fiscal 2013, growing its quarterly revenues and diluted earnings per share by 10% and 37%, respectively. This also represented the 18th consecutive quarter that it has managed to achieve in excess of 15% growth in diluted EPS.

Going forward, I am positive on plans for a new distribution center to be opened in Western Chicago in the third quarter of fiscal 2014. This new distribution center will support O'Reilly's expansion efforts beyond its 100-plus stores in Chicago, the third-largest population center in the U.S., and ease capacity pressures in the surrounding distribution centers.

Peer comparison
O'Reilly's peers include AutoZone and Pep Boys .

AutoZone is the largest auto parts chain in the country, but its commercial business is much smaller than that of O'Reilly, accounting for only about 16% of its fiscal 2013 sales. Furthermore, AutoZone's distribution network is inferior to O'Reilly's. While O'Reilly boasts of 24 distribution centers and 251 hub stores, AutoZone's distribution network comprises only eight distribution centers and 140-plus hub stores. It will take some time before AutoZone catches up with O'Reilly in terms of parts availability to compete in the commercial segment.

For the fourth quarter of fiscal 2013, AutoZone's quarterly revenues and diluted EPS increased by 12% and 15%, respectively. The normalization of weather conditions in areas previously suffering from cold weather was likely a key contributor to the improved financial performance. The growth in EPS was also partially boosted by the repurchase of 1.3 million shares for $560 million. AutoZone's weak balance sheet is also a concern for investors, with a debt load equivalent to more than a quarter of its market capitalization.

Pep Boys is differentiated from both O'Reilly and AutoZone, as it is not a pure auto parts retailer. Instead, it derived 53% of its fiscal 2012 revenue from automotive repair services, with auto parts sales to DIY and commercial customers making up for the remaining revenues. Automotive repair services has slightly higher barriers to entry than auto parts retail due to capital intensity and technical expertise, but it remains fragmented.

Pep Boys delivered a disappointing set of financial results for the second quarter of fiscal 2013, with a 0.4% increase in revenues and a 1.3% decrease in comparable sales. Despite this, it attributed the flat revenues to lower tire sales, but maintained that its maintenance and repair services business remained steady with increased customer count. Looking ahead, the increasing complexity of cars and changes in consumer mind-set are potential drivers for consumers shifting from DIY to professional repair services.

The road ahead
O'Reilly is a buy in my books because of its extensive distribution network and ability to scale up through consolidation. Moreover, it has a relatively strong balance sheet and the countercyclical nature of its revenues acts as a hedge for one's stock portfolio.

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Fool contributor Mark Lin has no position in any stocks mentioned. The Motley Fool owns shares of O'Reilly Automotive. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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