Weak Consumer Spending Doesn’t Hold Back This Auto Stock

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Weak Consumer Spending Doesn’t Hold Back This Auto Stock

By: Elliott Gue

The economic recovery is more than two years old but US gross domestic product (GDP) continues to limp along at a lackluster 2 percent annualized pace, unemployment remains at an elevated 8.2 percent and the housing market is at best scraping bottom.

Even worse, unemployment soars to nearly 15 percent if you factor in the millions of underemployed workers and those discouraged workers who gave up looking for a job. By most metrics, the recovery since mid-2009 is one of the weakest expansions in post-war economic history and tepid growth is likely to continue for the rest of the year.

Not surprisingly, US consumers along with their counterparts in Europe and other developed markets are saving more and spending less, bad news for most retailers. However, some consumer-focused companies are actually benefiting from the new age of austerity.

As the chart “More Fixer-Uppers” shows, the weak housing market has severely hit investment in new home construction. The silver lining is that many consumers are instead remodeling and maintaining existing properties.

Foreclosed homes are typically in bad shape when they’re acquired at auction from banks; new owners must upgrade and repair these properties to make them suitable for resale. Improvements and remodeling now account for more than 42 percent of all investment in retail housing, up from about 21 percent at the height of the housing boom.

The same principle is at work with automobiles. The US new car market currently stands at 13.7 million annualized vehicles, down from an average of about 18 million before the Great Recession of 2007-2009. Instead of splurging on a new car every few years, consumers are keeping their existing vehicles longer, pushing up the average age of US cars (see “Driving More Clunkers”). The need to repair and maintain older vehicles is powering demand for retailers of automobile parts and tools.

One stock that stands to gain from cost-conscious consumer spending is Autozone (NYSE: AZO).

Autozone is the largest automobile parts and accessories retailer in the US, with more than 4,600 domestic store locations and 300 in Mexico.

The company sells products in three main categories: failure, maintenance and discretionary. Failure items include major mechanical parts in automobiles and trucks that wear out over time such as air conditioning compressors, fuel pumps, fuses and lights.

Maintenance items include non-discretionary products that must be replaced over time such as oil, windscreen washing fluid and transmission fluid, while discretionary items include waxes, floor mats and air fresheners.

The first two categories of products are direct beneficiaries of the current tendency of consumers to keep their cars longer. Cars older than 7 years typically have more than 85,000 miles on the odometer and are no longer covered by warranty; they require more frequent and expensive repairs.

The number of cars in this age group has exploded since 2007, as sales of new cars have fallen sharply and the average age of US cars reaches record levels (for more on the US car market, see Perfect Storm for Palladium Could Bode Well for Stillwater).

Autozone has traditionally served a primarily DIY customer base. Sales to that group continue to perform well, but the do-it-for-me (DIFM) market that consists of professional mechanics has stronger growth prospects.

Over the past 12 months, sales to DIFM customers totaled $1.2 billion, around 15 percent of the company’s total revenue base, and they’re growing at a more than 21 percent pace year-over-year, compared to a total revenue growth rate of only 8 percent.

One driver of that growth is Autozone’s roll-out of its commercial sales program across its retail locations, allowing professional customers to buy parts on credit, with expanded online ordering and delivery.

Management believes that Autozone only has 2 percent market share in auto parts sales to professional buyers, suggesting there’s plenty of upside.

Autozone shares were hit in late June after competitor O’Reilly Auto Parts (NSDQ: ORLY) lowered its quarterly comparable store sales guidance, citing sales below expectations in June.

However, this softening in sales partly stems from the extraordinarily warm winter of 2011 to 2012, which prompted customers to buy parts earlier in the year. For more on Autozone, see 2 Auto Repair Stocks Set to Race Ahead.