Monday, September 13, 2010

AutoZone (NYSE:AZO): Downgrade to Sell - Goldman Sachs

Goldman Sachs is downgrading AutoZone (NYSE:AZO) to Sell from Neutral with a $213 price target (prev. $211).

The firm notes tht in their view, AZO is one of the finest companies in retail. The company has operated a finely tuned stores organization, and executes as well as any in their coverage. An early and updated focus on systems and an audacious private label merchandising program have combined to drive the highest operating margins in hardlines, and some of the best financial returns in retailing. Moreover, the sector has benefited from robust tailwinds as sluggish new car sales have increase consumers’ focus on maintenance and refurbishment of aging automobiles, and a difficult economy has led to growth in AZO’s core demographic – consumers who fix their own cars out of economic necessity.

Goldman says that as they scour they sector for prospective underperformers, they are reluctant to make an outright cyclical bet, in either direction. In firm's view, investor psychology is negative, and consumer spending growth is tepid, however, macro indicators are not all punitive, and neither current trends nor macro factors point outright to a double-dip. As such, their long calls are focused on firms with company-specific drivers that are underappreciated by the market, while their Sell calls are focused on firms more dependent on macro momentum for growth where growth prospects are fully or fairly priced.

AZO’s margins are at long-run peaks, and stand solidly above peers on all bases, reflecting the co’s scale; its stable, consistent business model – no major acquisitions in recent years, same management team since 2005; its private label penetration; and its stellar execution. With increased head-to-head competition from industry leaders, most notably reflecting ORLY’s takeover of CSK in the Western US, and an initiative to drive sales to commercial customers, typically a lower-margin effort than AZO’s core DIY business (~88% of sales), meaningful margin expansion is unlikely from here.

Note that the company’s margins have been relatively stable in recent years, a reflection of the difficulty to increase sector high margins for a company with leading market share in the higher margin DIY segment, and as the company makes headway in the lower margin DIFM space.

While sales forecasts should prove achievable in the short run, the sector will soon confront multiple years of solid comparisons; Goldman expects deceleration to commence with the current quarter, and to continue, albeit unevenly, going forward.

Goldman expects this call to play out through subdued reactions to solid numbers. AZO reports August quarter results on September 21; they expect a solid showing, with some potential upside to their 4% same-store forecast and their EPS estimate of $5.40 (essentially in line with consensus of $5.42), based on strong recent sales from peers. This quarter should mark the first sequential deceleration in same-store trends, which the firm expects will continue through fiscal 2011.

Notablecalls: I've seen several AZO downgrades over the past year but this is the first one that makes some sense & has a visible catalyst. Fassler, the Goldman analyst sees AZO as the best play in retail but also acknowledges the lack of upside. The call is definitely different from the oh-my-god-this-is-so-expensive-sell-it-fast type of calls I have seen out of other firms.

AZO is set to report its CQ3 results in a week and I would not be surprised to see the stock fade on in-line results.

Given the nature of the stock I don't expect it to break down instantly, but this may be the straw that ultimately breaks the camel's back.

Worth keeping on radar.

1 comment:

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