Autozone Case Study

Background

        In 1987, AutoZone installed the retail industry’s first electric auto-parts catalog.  Four years later, they were listen on the NYSE, and by 2012, they had become the leading retailer of automotive replacement parts and accessories in the US.  AutoZone heavily invested in their retail growth.  This led to varying success in top-line revenue and the highest operating margin in the industry.  They also were well known for their strong customer service.  Recent news of their main shareholder Edward Lampert rapidly liquidating his stake in the company, made portfolio manager, Mark Johnson concerned.  AutoZone currently practiced a share repurchase strategy. From 2007 to 2011, the outstanding shares of the company were reduced by 39%.  This triggered shareholders’ equity to drop to a negative $1.2 billion in 2011.  The repurchase of shares had been funded by the strong cash flows of the company as well as the issuance of debt.  The result of the program was a strong ROIC in 2011, at 31%.  Johnson felt the share repurchase strategy was because of Lampert, because they started the program when Lampert bought a stake in the company.

Problem

        .  Now that Lampert was reducing his investment in the company, Johnson had to figure out the impact of changing strategies from share repurchases to using its cash flow for cash dividends or reinvestment.  He also had to assess the impact of those decisions on the company’s stock price, which had increased by 1250% from 1996 to 2011.  Johnson needed to find a way that with Lampert selling his stake, the company could remain profitable, and investors could retain their confidence in the company.  Johnson also had to consider whether growing the company by means of mergers and acquisitions was best.  In the past, AutoZone had acquired over 800 stores from its competitors.  Another way Johnson could improve the company’s profitability was by retiring their current debt outstanding.  This would protect the company from the problem of not being able to pay back their interest on their debt, and therefore, losing their investment grade credit rating.  Overall, Johnson had to decide if he should keep his investment in AutoZone in his portfolio, and to find out why the company’s stock price had risen so much.

Conclusion

        First, I looked at why AutoZone’s stock price had such a large increase in stock price.  The main factor behind the increase in stock price was the stock repurchase program.  Share repurchase program decreased the number of shares outstanding and therefore, created a strong EPS and increased the price of the stock.  EPS is one of the most significant estimations that investors overview because the market price of the stock is reflected with the EPS of the company.  Even though EPS is not a good estimation of a company’s performance, because it can be manipulated many different ways, it does reflect the market price of the stock.  In 2011, AutoZone had more than 44,000 shares outstanding, and in 2015, the number of shares was reduced to 32,000.  This led to an increase of 85.05% in EPS, from $19.47 in 2011, to $36.03 in 2015.  The share price increased 65.85% from $253 to $741 from 2011 to 2015.  This proves that an increase in EPS has helped to increase investor confidence, and therefore, increase the stock price of the company.

        Second, AutoZone could distribute their cash flows in the form of cash dividends.  However, unlike share repurchases which appear to offer cash only to shareholders open to sell their shares, dividend payouts provide cash to all common stockholders.  Dividends are taxed at the shareholder level also.  Dividends are expected to remain at a steady rate or increase from year to year.  On the other side, if dividends decrease, it becomes a negative signal to the market and could cause the stock price to drop because of lack of shareholder confidence.

        Third, AutoZone could grow by means of organic growth, or more simply, opening more stores.  Although analysts think that the auto retail market is becoming saturated, AutoZone’s CEO believes the opposite.  The company could use this opportunity to reinvest its operating cash flows into new stores, especially in less profitable territories, eventually preventing competitors from gaining new market share.  However, they would have a risk of not maintaining the proper managerial capacity to oversee the large amount of stores.  Also, expanding would most likely provide AutoZone with the same return on investment they already have.  Although there were very attractive overseas investment opportunities, their current distribution network would be severely strained if they chose to expand into foreign markets.  Overall, it would be difficult for the company to invest its operating cash flows into expansion because of the risks involved.

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