AutoZone Inc.'s Expansion Pace Turns Negative

By Demitrios Kalogeropoulos Markets Fool.com

AutoZone (NYSE: AZO) this week posted earnings results that showed increasing pressure on its revenue and profit growth. Sales at existing locations declined, and the auto parts retailer's earnings inched up at less than a double-digit pace for only the second time in 11 years.

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Here's how the big-picture results from the company's third fiscal quarter stacked up against the prior year:

Metric

Q3 2017

Q3 2016

Year-Over-Year Change

Revenue

$2.62 billion

$2.59 billion

1%

Net income

$332 million

$328 million

1.3%

EPS

$11.44

$10.77

6.2%

Data source: AutoZone.

What happened this quarter?

AutoZone's fiscal third quarter never fully recovered from a slow start that management pinned on IRS tax refund delays. Weak conditions in the retailing industry, meanwhile, kept a lid on customer traffic growth.

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Image source: Getty Images.

Highlights of the quarter included:

  • Sales inched higher by 1% as the company added 35 new stores to its U.S. footprint and eight more in Mexico.
  • Comparable-store sales fell 0.8%, marking another quarter of a decelerating growth pace. Comps were flat in the prior quarter and up 1.6% in its fiscal first quarter.
  • Gross profit margin ticked down to 52.6% of sales from 52.8%.
  • E-commerce sales slipped lower by 2.5%.
  • Operating expenses worsened slightly, growing to 32.4% of sales as the company spent more on employee wages.
  • Inventory rose 7% as a growing store base met with weakening sales at existing locations.
  • Return on invested capital fell to 30.5% from 31.2%.
  • AutoZone spent $284 million on stock buybacks, which helped push earnings per share up 6% even though net income rose by less than 2%.

What management had to say

"Oursales performance for the first five weeks of our quarter was significantly below our expectations," CEO Bill Rhodes said in a press release while citing the same IRS refund timing issue that hurt the business last quarter. "The last seven weeks of sales demonstrated improvement, but not enough to make up for our soft start," Rhodes continued.

Management noted that they see a few major challenges ahead, including increasing wage pressure that threatens to hold back profit growth. Nevertheless, Rhodes and his team said they are "confident in our long-term positive fundamentals for sales growth."

Looking forward

With three quarters of its fiscal year behind it, AutoZone appears set to post a significant sales growth dip in fiscal 2017. Comps are up just 0.2% over the past nine months, compared to a 3% increase in the prior-year period. Earnings, up 9% so far, also aren't likely to meet the prior year's 13% growth pace.

The retailer's focus during this slowdown is on improving the customer experience through initiatives like expanding its distribution network so that stores can offer a wider, better-stocked selection of products as delivery frequency rises. Increased labor costs will hurt the bottom line in the short term, but should also help the retailer stay competitive by keeping a strong base of engaged, experienced employees. Investors will be looking for these moves to contribute to improving comps trends over the next few quarters.

Looking further out, AutoZone believes that its tiny online business will eventually grow much more important to the operation. The soft results in that channel so far this year imply that management may need to direct more resources toward bulking up its e-commerce segment. After all, more customers are opting to go online to make their automotive parts purchases, so AutoZone has no choice but to establish itself as a leader in this channel.

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Demitrios Kalogeropoulos has no position in any stocks mentioned. The Motley Fool recommends AutoZone. The Motley Fool has a disclosure policy.