AutoZone, Inc. (NYSE:AZO) Q2 2023 Earnings Call Transcript

AutoZone, Inc. (NYSE:AZO) Q2 2023 Earnings Call Transcript February 28, 2023

Operator: Greetings. Welcome to AutoZone’s 2023 Q2 Earnings Release Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note, this conference is being recorded. Before we begin, the company would like to read some forward-looking statements.

Brian Campbell: Before we begin, please note that today’s call includes forward-looking statements that are subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are not guarantees of future performance. Please refer to this morning’s press release and the company’s most recent annual report on Form 10-K and other filings with the Securities and Exchange Commission for a discussion of important risks and uncertainties that could cause actual results to differ materially from expectations. Forward-looking statements speak only as of the date made and the company undertakes no obligations to update such statements. Today’s call will also include certain non-GAAP measures. A reconciliation of non-GAAP to GAAP financial measures can be found in our press release.

Operator: I will now turn the conference call over to your host, Bill Rhodes, Chairman, President and Chief Executive Officer. Sir, you may begin.

Bill Rhodes: Good morning. And thank you for joining us today for AutoZone’s 2023 second quarter conference call. With me today are Jamere Jackson, Executive Vice President and Chief Financial Officer; and Brian Campbell, Vice President, Treasurer, Investor Relations and Tax. Regarding the first quarter, I hope you have had an opportunity to read our press release and learn about the quarter’s results. If not, the press release, along with slides complementing our comments today, are available on our website www.autozone.com under the Investor Relations link. Please click on Quarterly Earnings Conference Calls to see them. As we begin, we would like to thank and congratulate our AutoZoners across the company for their commitment to delivering exceptional customer service.

For the second quarter, our team delivered total sales growth of 9.5% versus 8.6% in the first quarter, in line with our expectations. We were pleased with this performance as we were up against 15.8% total sales growth in last year’s second quarter. We could not have achieved these results without phenomenal contributions from across the organization. Once again, our AutoZoners’ efforts generated double-digit domestic commercial growth and single-digit domestic retail same-store sales growth. As we move further and further away from the societal impacts experienced as a result of the pandemic, we are very pleased with our team’s ability to not only retain the tremendous growth we experienced over the last three years, but continue to grow on top of those phenomenal levels.

Our team is relentlessly focused on getting back to normal or, as I call it, quote-unquote, exiting pandemic mode. We must get back to our well-known and highly regarded flawless execution. In all candor, we still aren’t there yet. But we also have to reignite our innovation engine. We have some very good initiatives in development in both retail and commercial, and we have some significant improvements underway in our supply chain, as we modernize and expand it for the next decade of growth and beyond. We are halfway through our fiscal year and we are pleased with our performance so far. More encouraging, we feel good about the balance of the year and know our AutoZoners are keenly focused on delivering great service and terrific performance.

This morning, we will review our second quarter same-store sales, DIY versus DIFM trends, our sales cadence over the 12-week quarter, merchandise categories that drove our performance and some regional call-outs. We will also share how inflation is affecting our cost and retails, and how we think inflation will impact our business for the remainder of our fiscal year. Let’s now move into more specifics on our performance. Domestic same-store sales were up 5.3%, our net income was $477 million and our EPS was $24.64 a share, increasing 10.5%. Our domestic same-store sales comp was on top of last year’s 13.8% and in line with last quarter’s 5.6% comp. On a two-year basis, we delivered a 19.1% comp, and get this, on a three-year basis, a 34.3% stacked comp.

Our team once again delivered amazing results despite the comparison to the last couple of years being the hardest quarterly compare for the entire fiscal year. Now let me spend a few moments on growth, our growth dynamics in the quarter. Our growth rates for retail and commercial were both strong, with domestic retail sales up nearly 5% and domestic commercial growth north of 13%. We continue to set commercial quarterly records with $955 million in sales, another impressive quarter as we generated $111 million more in sales than in Q2 last year. On a trailing four-quarter basis, we delivered just under $4.5 billion in annual commercial sales, up an amazing 19% over last year. We also set another Q2 record for average weekly sales per store at $14,500 versus $13,500 last year.

Domestic commercial sales represented 30% of our domestic auto parts sales versus 28% this time last year. It was encouraging to see our transaction trends improving from last quarter. Our retail transactions meaningfully improved and were down just 2.2% for the quarter, while our commercial transactions were up mid-single digits and improving. Our average ticket in both retail and commercial experienced solid mid single-digit growth. Ticket growth decelerated from Q1 as we began to lap the acceleration in inflation we experienced this time last year. We are beginning to see signs of product cost and freight inflation slowing, and we expect to see these begin to return to historical norms over time. We are continuing to see — to experience substantially higher wage inflation than historically in the mid single-digit range, more than double our historical experience.

While the staffing environment is substantially improved versus this time last year, we don’t envision wage inflation abating soon as there continues to be regulatory and market pressures. While we have to manage through these external forces, our focus continues to be on driving profitable market share growth, particularly in units and transactions. Our growth initiatives are doing just that and include, new store unit growth, improved satellite store availability, hub and mega-hub openings, improvements in coverage, leveraging the strength of the Duralast brand, enhanced technology to make us easier to do business with and more efficient, reducing delivery times, enhancing our sales force effectiveness and living consistent with our pledge by being priced right for the value proposition we deliver.

Our goal remains over time to become the industry leader in both DIY and commercial. Our strategy, execution and market momentum give us confidence as we move forward. Digging deeper into our domestic DIY business this past quarter, we delivered a positive 2.7% comp on top of last year’s 8.4%. Our DIY results were similar to last quarter’s results on a one-year and two-year basis and accelerated on a three-year basis. As previously said, our ticket growth was up 5% versus last year. We are pleased with our transaction count trends improving as we reported transactions down just 2%. These results are very strong, considering the difficult comparison to last year. From the data we have available, we continued to retain the majority of the dollar share gains we have built during the pandemic and we continue to grow unit share, a critical measurement of our success.

Our performance gives us continued conviction about the sustainability of our sales growth for the remainder of the year. As we have shared forever, our second quarter is always the most volatile sales quarter due to the holidays, their timing shifts, and more importantly, weather, specifically extreme temperatures, which all can have a tremendous impact on our weekly sales. This quarter was no different, with softer sales at the beginning of the quarter when the weather was mild and wet, followed by a large spike around Christmas with the very cold temperatures the country experienced. We exited the quarter with normalized growth rates. We do believe we had enough harsh winter weather that we won’t be talking about the lingering effects of a mild winter weather or mild winter for the next several months.

Our attention has now turned to tax rebate season, which historically drives enormous demand in our category. Regarding our retail merchandise categories, our sales floor outperformed hard parts with approximately a 1.5% difference between them. Our relative outperformance in sales for categories is attributable to the discretionary categories improvement. As gas prices naturally have come down and consumer has shown surprising resiliency, our discretionary categories performed better. The discretionary categories represented approximately 18% of our DIY sales in the quarter. We were encouraged to see our battery, oil and wiper categories performed well and successfully lapped very strong performance last year. These categories have exceeded our expectations all year.

Our friction category for both DIY and commercial performed below our expectations for much of the quarter. However, it bounced back late and we are encouraged by our recent trends. We believe both our sales floor and hard parts businesses will continue to do well this spring, as we expect miles driven to continue improving, while our growth initiatives continued delivering solid results. Let me also address pricing. In Q2, we experienced high single-digit pricing inflation in line with cost of goods. We believe both numbers will decrease in the current quarter as we begin to lap the onset of high inflation last year. To be clear, we do not believe inflation is going away, especially wage inflation, but expect it to slow a bit as the economy slows.

I want to highlight that our industry has been disciplined about pricing for decades, and we expect that to continue. Most of the parts and products we sell in this industry have low price elasticity, because purchases are driven by failure or routine maintenance. Historically, as costs have increased, the industry has increased pricing commensurately to maintain margin rates, increasing margin dollars. It is also notable that following periods of higher inflation, our industry has historically not meaningfully reduced pricing to reflect lower cost. Over the last three years, we have encouraged investors to keep a keen focus on our two-year and three-year comparisons. As we return to normal, we believe our year-over-year comparisons will be more and more relevant.

While it’s difficult to predict sales, we are excited about our growth initiatives. Our team is improving execution and the tremendous share gains we have achieved in both sectors. For our third quarter 2023, we expect our sales performance to be led by the continued strength in our commercial business as we execute on our differentiating initiatives, combined with the resilient DIY business. We will as always be transparent about what we are seeing and provide color on our markets and performance as trends emerge. Before handing the call to Jamere, I’d like to give a brief update on our supply chain initiatives. I will start with our in-stock position. I spent several quarters talking about how we were not back to where we were pre-pandemic.

I am pleased to report, we are continuing to improve and are very close to our targets. Our merchandising and supply chain teams have worked diligently and creatively to get our levels back up, and we have made enormous progress. There are still a few categories where we are not where we want to be, but we will — we have line of sight to putting this behind us. This has taken a lot of effort by our vendor community, and I’d like to publicly thank them for their tremendous efforts as well. We know this will pay future dividends. Second, our supply chain initiatives that are in flight to drive improved availability are on track. One we have often highlighted is our expanded hub and mega-hub rollouts. We know intelligently placing more inventory in local markets closer to the customer will lead to our ability to continue to say, yes, to our customers more frequently and in turn drive sales.

Additionally, we have previously announced the development of two new domestic distribution centers and additional capacity in Mexico. All three efforts are under construction and are expected to be completed by early fiscal 2025. These distribution centers will allow us to not only reduce drive times to stores but also increase our capacity. With the tremendous sales growth we have experienced since 2020, the additional capacity will enable us to carry more slower turning inventory that is not yet in high demand. I am excited that — I am also excited we opened a facility on the West Coast recently to handle direct import product on a timelier and more effective and efficient basis. This new West Coast facility is already paying dividends by allowing products ordered abroad to be distributed to our other DCs to reduce safety stock and drive productivity.

Our supply chain strategy is focused on carrying more products closer to the customer and we believe it has been a significant contributor to our recent sales success, especially in commercial. Simply put, every time we intelligently add inventory to our network our sales grow. Lastly, we plan on continuing to grow our business in Mexico and Brazil at almost 800 stores combined across the two markets. These businesses had impressive performance again this quarter and they should continue to be key contributors to sales and profit growth for decades to come. We are leveraging many of the learnings we have in the U.S. to refine our offerings in Mexico and Brazil. In Brazil, in particular, we are targeting to expand our store footprint significantly and aggressively over the next five years.

We are very excited about our growth prospects internationally. We are dedicated to growing our business in a disciplined and profitable manner well into the future, and we know, with our AutoZoners leading the charge, we will continue to be very successful. Now I will turn the call over to Jamere Jackson. Jamere?

Jamere Jackson: Thanks, Bill, and good morning, everyone. As Bill mentioned, we had a strong second quarter stacked on top of exceptionally strong comps from last year. This quarter we delivered 5.3% domestic comp growth, a 6.9% increase in EBIT and a 10.5% increase in EPS. To start this morning, let me take a few moments to elaborate on the specifics in our P&L for Q2. For the quarter, total sales were just under $3.7 billion, up 9.5%, reflecting continued strength in our industry and solid execution of our growth initiatives and let me give a little more color on those growth initiatives. Starting with our commercial business for the second quarter. Our domestic DIFM sales increased just over 13% to $955 million and were up just over 45% on a two-year stack basis.

Sales to our domestic DIFM customers represented 30% of our domestic auto part sales. Our weekly sales per program were $14,500, up 7.4% and our growth was broad-based as both national and local accounts performed well for the quarter. Our results for the quarter set another record for the highest second quarter weekly sales volume in the history of the chain. I want to reiterate that our execution on our commercial acceleration initiatives continues to deliver exceptionally strong results, as we grow share by winning new business and increasing our share of wallet with existing customers. We have a commercial program in approximately 88% of our domestic stores, which leverages our DIY infrastructure and we are building our business with national, regional and local accounts.

This quarter we opened 41 net new programs, finishing with 5,500 total programs. As expected, commercial growth is leading the way in FY 2023 and we continue to deliver on our goal of becoming a faster-growing business. Our strategy and execution continue to drive share gains and position us well in the marketplace. We have delivered double-digit sales growth for the past 10 quarters. In addition, we are increasing the penetration of our market leading ALLDATA shop management, diagnostic and repair software suite to new and existing commercial customers, which gives us yet another key competitive advantage. And as I have noted on past calls, our mega-hub strategy is driving strong performance and positioning us for an even brighter future in our commercial and retail businesses.

Once again, I will add some color on our progress. As we have discussed over the last several quarters, our mega-hub strategy has given us tremendous momentum. We now have 81 mega-hub locations with one new one opened in Q2. While I mentioned a moment ago, the commercial weekly sales per program average was $14,500, the 81 mega-hubs averaged significantly higher sales than the balance of the commercial footprint and grew significantly faster than our overall commercial business in Q2. As a reminder, our mega-hubs typically carry 80,000 to 100,000 SKUs and more in certain cases and drive tremendous sales lift inside the store box, as well as serve as an expanded assortment source for other stores. The expansion of coverage and parts availability continues to deliver a meaningful sales lift to both our commercial and DIY business.

These assets are not only performing well individually, but the fulfillment capability for the surrounding AutoZone stores is giving our customers access to thousands of additional parks and lifting the entire network. This strategy is working. We are targeting 25 new mega-hubs for FY 2023 and we remain committed to our objective to reach 200 mega-hubs, supplemented by 300 regular hubs. We continue to leverage sophisticated data analytics to expand our market reach, placing more parts closer to our customers and improving our delivery times. We will build on our strong momentum over the remainder of the fiscal year. Our domestic retail comp was up 2.7% in Q2. This business has been remarkably resilient as growth rates remain solid and we have managed to continue to deliver positive comp growth despite underlying market headwinds.

As Bill mentioned, we saw our traffic down 2.2% from last year’s levels. However, they improved sequentially from Q1 where traffic was down 4%. We also saw 5% ticket growth as we continue to raise prices in an inflationary environment. Our DIY business has continued to strengthen competitively behind our growth initiatives. In addition, on a macro basis, the market is still experiencing a growing and aging car park, and a still challenging new and used car sales market for our customers. These dynamics, pricing growth initiatives and macro car park tailwinds have driven a positive comp despite tough comparisons from last year’s stimulus injection and consumer discretionary spending pressure from overall inflation in the economy. We are forecasting a resilient DIY business for the remainder of FY 2023.

Now I will say a few words regarding our international businesses. We continue to be pleased with the progress we are making in Mexico and Brazil. During the quarter, we opened one new store in Mexico to finish with 707 stores and five new stores in Brazil ending with 81. On a constant currency basis, we meaningfully accelerated our sales growth in both countries at higher growth rates than we saw in the overall business. We remain committed to our store opening schedules in both markets and expect both countries to be significant contributors to sales and earnings growth in the future. With 11% of our total store base currently outside the U.S. and a commitment to continued expansion in a disciplined way, international growth will be an attractive and meaningful contributor to AutoZone’s future growth.

We are bullish on international growth, and as Bill mentioned earlier, we are adding distribution center capacity in Mexico to improve our competitive positioning in the market. Now let me spend a few minutes on the rest of the P&L and gross margins. For the quarter, our gross margin was down 69 basis points and included a 27-basis-point headwind stemming from a noncash $10 million LIFO charge. The difference for the quarter, a decline of 42 basis points in gross margin was driven by supply chain costs and our faster growing lower gross margin commercial business. With this quarter’s LIFO charge, we have taken our LIFO credit balance to $106 million. As I mentioned last quarter, hyperinflation and freight cost is the primary driver for the charges.

Both the first quarter and second quarter actuals are below the outlook we gave at the start of each quarter as freight costs have continued to abate over the past few months and we expect this trend to continue. As such, we anticipate having minimal if any LIFO charges during the third quarter. As spot rates have come down, we have renegotiated some of our long-term contracts and the lower costs are reflected in our outlook. We expect freight costs to continue to abate. We expect to see these quarterly charges start to reverse during FY 2024, and quite possibly, as early as Q4. We plan to take P&L gains only to the extent of the charges we have taken thus far and after we have taken P&L gains that fully reverse the charges we have incurred, we expect to rebuild our unrecorded LIFO reserve balance as we have done historically.

Now moving to operating expenses. Our expenses were up 8.8% versus last year’s Q2 as SG&A levered 24 basis points versus last year. Our operating expense growth has been purposeful as we continue to invest at an accelerated pace in IT and payroll to underpin our growth initiatives. These investments are expected to pay dividends and customer experience, speed and productivity. We are committed to being disciplined on SG&A growth as we move forward and we will manage expenses in line with sales growth over time. Moving to the rest of the P&L. EBIT for the quarter was $670 million, up 6.9% versus the prior year’s quarter. Excluding the $10 million LIFO charge, EBIT would have been up 8.5% over last year. Interest expense for the quarter was $65.6 million, up 54.5% from Q2 a year ago, as our debt outstanding at the end of the quarter was $7 billion versus $5.8 billion at Q2 end last year.

We are planning interest in the $72 million range for the third quarter of fiscal 2023 versus $42 million in last year’s third quarter. Higher debt levels and expected continuing higher borrowing costs are driving this increase. For the quarter, our tax rate was 21.2% and above last year’s second quarter rate of 19.3%. This quarter’s rate benefited 222 basis points from stock options exercised, while last year’s benefit was 401 basis points. For the third quarter of FY 2023, we suggest investors model us at approximately 23.4% before any assumption on credits due to stock option exercises. Now moving to net income and EPS. Net income for the quarter was $476.5 million, up 1% versus last year’s second quarter. Our diluted share count of 19.3 million was 8.6% lower than last year’s second quarter.

The combination of higher net income and lower share count drove earnings per share for the quarter to $24.64, up 10.5% versus a year ago. Excluding the LIFO charge, our net income would have increased 2.6% and our EPS growth would have increased 12.3%. Now let me talk about our free cash flow for Q2. For the second quarter, we generated $210 million in free cash flow versus $260 million a year ago. Year-to-date, we have generated $900 million versus $930 million a year ago. We expect to be an incredibly strong cash flow generator going forward and we remain committed to returning meaningful amounts of cash to our shareholders. Regarding our balance sheet, our liquidity position remains very strong and our leverage ratios remain below our historic norms.

Our inventory per store was up 10.7% versus Q2 last year and total inventory increased 13.9% over the same period, driven primarily by inflation, our growth initiatives and in-stock recoveries. Net inventory, defined as merchandise inventories less accounts payable on a per store basis was a negative $227,000 versus negative $198,000 last year and negative $249,000 last quarter. As a result, accounts payable as a percent of gross inventory finished the quarter at 127.7% versus last year’s Q2 of 126.8%. Lastly, I will spend a moment on capital allocation and our share repurchase program. We repurchased 906 million of AutoZone stock in the quarter, and at quarter end, we had just under $1.8 billion remaining under our share buyback authorization.

Our strong earnings, balance sheet and powerful free cash generated this year have allowed us to buy back 4% of the company’s total shares outstanding since the start of the fiscal year. We bought back well over 90% of the shares outstanding of our stock since our buyback inception in 1998, while investing in our existing assets and growing our business. We remain committed to our disciplined capital allocation approach that enables us to invest in the business, while returning meaningful amounts of cash to shareholders. Our leverage ratio finished Q2 at 2.3 times EBITDAR and we remain committed to return to the 2.5 times area during FY 2023. So to wrap up, we continue to drive long-term shareholder value by investing in our growth initiatives, driving robust earnings and cash, and returning excess cash to our shareholders.

We are growing our market share, and we are improving our competitive positioning in a disciplined way. Our strategy continues to work. As we look forward to the back half of FY 2023, we are bullish on our growth prospects behind a resilient DIY business and fast growing commercial and international businesses that are growing considerable share. I continue to have tremendous confidence in our industry, our business and the opportunity to drive long-term shareholder value. And now I will turn it back to Bill.

Bill Rhodes: Thank you, Jamere. We are proud of the results our team delivered in the second quarter. But we must, we must continue to be focused on superior customer service and flawless execution. Execution and our culture of always putting the customer first is what defines us. As Jamere said a moment ago, we continue to be bullish on our industry, and in particular, on our own opportunities for the remainder of the year. We will continue to invest in initiatives that drive an appropriate return on capital and we continue investing where our returns are the highest. For the remainder of fiscal 2023, we are launching some very exciting initiatives. This year not only we would be opening roughly 200 stores across the U.S., Mexico and Brazil, but we will be opening many more mega-hub and hub stores, and we are focused on initiatives to continue driving strong performance in both our retail and commercial businesses.

For the remainder of 2023, we are keenly focused on relentless execution. We will not accept shortcuts. We remain focused on achieving our store opening goals, both domestically and internationally. We are working diligently to expand and enhance our supply chain and we have to achieve this growth, all while managing our costs appropriately. Simply said, we have to focus on exceptional execution in order to drive continued share gains. We know that investors will ultimately measure us by what our future cash flows look like in three to four years from now and we welcome and accept that challenge. I continue to be bullish on our industry, and in particular, on AutoZone, which is led by AutoZoners. Now we would like to open up the call for questions.

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Q&A Session

Operator: Certainly. Your first question for today is coming from Bret Jordan at Jefferies.

Bret Jordan: Hey. Good morning, guys.

Bill Rhodes: Good morning, Bret.

Jamere Jackson: Hi, Bret.

Bret Jordan: On the talk of lower transportation, supply chain costs but higher wage inflation, in this environment, where some of your inputs are going to come down and maybe you have got the opportunity to capture margin as customer prices stay firm, are we less likely to see this over for excess margin, because we have got either price investment from peers or wage inflation that might offset some of the cost of good benefit?

Bill Rhodes: Yeah. It’s a fantastic question, Bret. I will start, and Jamere, you are welcome to build on it if you want to. First of all, I think, it’s important for you all to understand, as we saw these enormous spikes in the freight cost, we did not pass all those costs along. I will use brake rotors, for instance. I mean the cost of shipping brake rotors from China to the U.S. were astronomical for a period of time. We couldn’t pass all that costs on to the industry. So some of this is we will recoup some gross margin percentages that we didn’t get in the midst of the freight issue. As we look forward, I think, you have to separate the gross margin piece from the labor piece. We are going to continue to see elevated wage growth.

We have seen it now for probably five years, Bret. We will continue to monitor that. Our pricing is really more focused on what our product costs are and what those freight costs are. We will be mindful of labor costs. But generally, that’s not a big driver of what we do with our pricing to the customer. What we need to do is make sure that we are finding ways to be as efficient as possible with the labor that we have, and over time, I think, wage rates will go back to more normalized growth rates.

Jamere Jackson: Yeah. And we haven’t seen the moves and actions by our nearing competitors impact our business, really at all. Most of those moves, quite frankly, were targeted in much the same manner as our moves were a couple of years ago, which was how do we all improve our competitive hand relative to the warehouse distributors. So we haven’t seen much of an impact there, and as a result of that, we don’t see a need to make pricing actions to sort of counter what’s being done in the marketplace by some of our newer competitors.

Bret Jordan: Okay. Great. And then a quick question on ALLDATA. I think you would mentioned expanding the user base. Is there a way to make that a product selling tool as they use your shop management software, is there a way to link it to your inventory or make it more transactional?

Bill Rhodes: Yeah. First of all, at ALLDATA, we are very focused on providing value via our ALLDATA offerings to our customers at ALLDATA. We also look for ways that we can enhance our commercial relationship at AutoZone with their customers. We have done a lot of that by cross-selling, leveraging our two sales teams to generate leads for each other. So far, we haven’t really integrated a lot with the, call it, up and down the street customer, but we have made some really meaningful progress with some of our national accounts and have some exciting things underway right now that helps integrate us more and more with them. Over time, that’s certainly the vision that we have, is how can we be on their desktop as both ALLDATA and AutoZone in a seamless way, but we got to make sure that we don’t drive the customer to that, that instead we have a product offering that the customer wants to adopt.

Bret Jordan: Great. Thank you.

Bill Rhodes: Yeah. Thank you.

Operator: Your next question for today is coming from Seth Sigman at Barclays.