AutoZone's Incredible Shrinking Shares

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

By Ivan Martchev for InvestorPlace

NEW YORK ( InvestorPlace) -- At the end of the latest reported quarter, auto parts retailer AutoZone ( AZO) had 38.95 million shares outstanding.

This number means little on its own, but when you consider than since 1998 the company has meticulously been repurchasing stock every year and in the process has managed to retire 128.8 million shares, you should take notice.

"Here comes AutoZone with yet another buyback," I thought, as the headline about the latest board authorization to repurchase $750 million worth of stock appeared on my computer screen.

I had known about AutoZone's regular buybacks for some time, but I had not considered the cumulative number of shares retired.

When I looked at it, I was surprised to see that management had retired 70% percent of shares outstanding since this rather interesting financial experiment began nearly 14 years ago.

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Any company's share price should feel the disappearance of more than two-thirds of the float, even if business stays flat.

In this case, AutoZone grew notably as the number of shares shrank dramatically.

Management did a lot to break into new commercial markets, which resulted in an acceleration of sales growth.

Over the past 10 years sales show a compounded annual rate of growth of 5.3%, a five-year CAGR of 6.3% and a three-year CAGR of 7.3%.

Because the share count shrank consistently as the company grew, earnings per share growth was much higher than any other measure of profit growth. This is why EPS show a 10-year CAGR of 23%, while earnings before interest and taxes (EBIT) has a 10-year CAGR of 6.3%.

"So why doesn't everyone do what AZO does?" I was asked when discussing AZO's above-mentioned strategy.

If one looks at other companies in the same industry, one discovers that AZO has the highest year-over-year revenue growth (8.6%), the highest gross margin (51.22%) and the highest operating margin (18.67%).

Yet AutoZone's shares are not valued higher than the industry average. They have a price-to-earnings ratio of 17.66 based on trailing earnings and a P/E of 14 based on forward earnings. It doesn't appear that anyone else in the industry has the cash flow to try to shrink shares so aggressively.

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But if no one in the auto parts industry can pull it off, perhaps the money manager that helped engineer this financial maneuver, Eddie Lampert of ESL Investments (general partner of RBS Partners, L.P.), has found some other retailers that can replicate this.

Perusing RBS Partners' latest 13F-HR filing shows his latest concentrated positions.

There are huge positions in retail stocks, and some of these companies are trying to pull off the same trick -- increase profitability while shrinking shares outstanding.

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Earlier this month, Big Lots ( BIG), a 1.65 million-share RBS Partners position, reported record fiscal 2011 total sales of $5.2 billion as well as a fifth consecutive year of record EPS.

This resembles the AZO situation, because the company invested $359 million to repurchase 11 million shares (approximately 15% of outstanding shares as of the beginning of fiscal 2011).

Big Lots has only about one-third of AZO's operating margin (6.64%), but the company has no net debt and the ability to keep doing a similar share shrinkage with a current float of 62.62 million shares.

With a P/E of 15, the shares of America's largest closeout retailer appear to be not that expensive, and it will be interesting to see how the ongoing share shrinkage plays out in this case.

Another huge retail position is The Gap ( GPS) with 31.17 million shares in the RBS Partners portfolio.

Similar to AutoZone, The Gap has done a lot to return cash to shareholders. The company recently approved a new $1 billion share repurchase authorization as well as an 11% increase in the annual dividend per share for 2012.

Since October 2004, The Gap has distributed about $13 billion in cash to shareholders, spending more than $11 billion in share repurchases to retire 570 million shares (only in fiscal 2011 they repurchased 111 million shares for $2.1 billion).

Given that currently The Gap has a market capitalization of $12.91 billion, the company has distributed its whole current market cap to shareholders since 2004.

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The above was highly necessary to (try to) revitalize the share price as The Gap has a five-year sales CAGR of -1.97% due to a big strategic error, in my opinion.

Banana Republic is The Gap's high-end division. It was doing well until The Gap decided to launch Old Navy, which caters to less-affluent consumers.

Since I bought two dress shirts from Banana Republic in 2008 and discovered that their quality was more appropriate for an Old Navy label, it took me three years to go to one of the company's stores again. Given the five-year negative sales growth, it looks like I am not the only one to have voted with his feet.

Given the Old Navy unfortunate detour, it would be difficult to turn around The Gap and refocus it to be more upscale again. This may be a retail business, but fashion is very different from auto parts. Still, this is another example of a very aggressive share buyback.

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The last big bet on retail in the RBS Partners portfolio is Sears Holdings ( SHLD) with a current 48 million-share position.

How putting two dying retailers in 2005 in the same company -- Sears and Kmart -- would make a more successful business operation was difficult to understand at the time, and now the skeptics have been vindicated.

Cost-cutting and streamlining the business worked for a while, and then the hazy strategy caught up with this problematic conglomerate, resulting in 19 consecutive quarters of declining sales.

I am not sure how this one gets resolved. They say Sears' real estate is where the value lies, but that would be like trying to make lemonade out of a lemon idea; I seem to remember the original intention for the merger with Kmart was to compete with Wal-Mart Stores. It appears that AutoZone's success is (nearly) impossible to replicate, even for Eddie Lampert.

Ivan Martchev is a research consultant with institutional money manager Navellier & Associates. The opinions expressed are his own. Navellier & Associates holds a position in AutoZone for its clients. This is neither a recommendation to buy nor sell the stocks mentioned in this article. Investors should consult their financial adviser prior to making any decision to buy or sell the above mentioned securities.


This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.

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