AutoZone Rattled by Signs of Slowdown

AutoZone ( AZO) is shifting out of overdrive.

With its old growth engine sputtering, the nation's largest auto-parts retailer is looking for a new way to soup up its performance. The company, which zoomed to prominence by catering to retail customers, is now steering its focus toward the commercial market.

AutoZone hopes to grow at an "accelerating pace" by rolling past smaller players and snatching up more of the $47 billion commercial market that, so far, it has barely tapped. Right now, AutoZone still relies on retail customers for roughly 90% of its business. But the company has become increasingly dependent on commercial sales -- which rocketed 30% in the latest quarter -- to fuel much of its growth.

"There's tremendous opportunity to gain market share" in the commercial sector, AutoZone CEO Steve Odland told investors in a conference call on Wednesday. "We're really confident in our model."

But some investors clearly prefer the model in the rearview mirror. They took one look at AutoZone's same-store sales for the third quarter -- flat at the retail level and up just 2.8% overall -- and sped away. The stock, trading near historic highs ahead of Tuesday night's earnings release, tumbled 3.3% to $84.50 Wednesday. Even a fresh buy recommendation from Legg Mason, which declared the quarter a strong one overall, couldn't stop the slide.

AutoZone CFO Mike Archbold insisted Wednesday that the company "hit it out of the park this quarter" and declined to speculate on the market's reaction.

"People can choose to buy or sell," he said. "But we did beat expectations. ... I think it was, overall, just a great quarter."

Knocks and Pings

But the market dwelled on AutoZone's weak points. Although the company managed to grow third-quarter earnings by 23%, it topped Wall Street expectations only with help from an unexpected 3-cent gain. Counting the gain, the company reported third-quarter profits of $1.30 a share instead of the $1.27 most analysts were anticipating.

This time last year, AutoZone delighted investors with a 23% upside surprise. But back then, AutoZone was boasting an 8.5% core growth rate that was nearly double the industry average. In more recent quarters, the company's performance has stalled. It reported overall sales growth of just 5.2% in the latest period, all of it from new stores and the expansion in commercial sales. Meanwhile, the company's ongoing retail sales -- once a highlight -- languished at last year's levels.

Still, Archfold defended even retail sales as strong. He said that last year's exceptional numbers have made for tough comparisons. And he applauded the company for holding on to customers nabbed during last year's boom.

"This is not an easy accomplishment," Odland agreed. "It's extremely encouraging."

But the company, which reported "record" numbers in virtually every category, has more than its share of doubters. AutoZone critics, betting heavily against the company's stock, have shorted a whopping 80% of the float. They know, already, that an accounting change will hurt next quarter's earnings. But they clearly believe that AutoZone faces fundamental challenges as well.

Even AutoZone's own CFO admitted the company must overachieve just to match its past performance. But he expressed confidence that the company will do just that.

"Are we always pushing for more?" he asked. "You bet. We're relentless."

Reaching for the Stars

Still, AutoZone stops short of telling anyone how high it's really aiming. The company, which is expected to deliver full-year earnings of $5.09 this year, offers no formal guidance itself.

"We just keep trying for the best day in and day out," Archbold said. "We don't know how high is high."

Until recently, Standard & Poor's included AutoZone in its "S&P Top 10 Portfolio," company picks that have historically performed three times better than the broader market. During the roughly 100 days AutoZone spent on the list, it rocketed 32% from $65 to $86 before S&P downgraded the stock to hold and removed it from the Top 10 because of its high valuation.

During that run-up, several insiders -- including AutoZone's controller, senior vice president and secretary -- exercised cheap options and immediately sold the stock at a profit. But by then, AutoZone insiders had regularly executed much larger stock sales. A few insiders, including the CEO, have occasionally purchased shares, however.

Still, Peter Cohan, the author of several popular investment books, sees potential reasons for concern. He specifically questions why AutoZone's profits have been growing so much faster than the company's sales. And he wonders how much longer those profits can continue to explode.

"Investors are concerned about sustainability," said Cohan, who has no position in the stock. "Is this a temporary blip, or does AutoZone have a real problem with its growth potential?

"That is the key question."

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