The answer questions of case study of autozone inc corporate finance strategies

Besides expanding the scale, AutoZone’s management also focused on after-tax return on invested capital ROIC as the primary way to measure value creation for the company’s capital provid

The Answer -questions of case study of AutoZone InC

(Corporate Finance Strategies)

AUTOZONE

Q#1 How has AutoZone’s stock price performed over the previous five years? What other financial measures can you cite that are consistent with the stock price performance?

AutoZone’s shareholders had enjoyed strong price appreciation since 1997, with an average annual return of 11.5% Over the previous five years, AutoZone’s stock price has increased dramatically On February 1 2012 the stock price was $348 compared to the $125 on February 1 2007 The strong price appreciation resulted from several occurrences; some of them are U.S

economy recession and share repurchase program Auto-part business was somewhat counter-cyclical Company’s growth and stock price were directly related to the economy and number of miles a vehicle had been driven As the age of car increased, more repairs were required Because of these reasons, AutoZone’s stock price was

significantly improving from 2008

AutoZone’s financial statements reflect the stock price performance Net sales have increased for 30.85% from 2007 to 2011 Cost of sales also increased during that period, but at lower rate of 27.30%, what helped in additional improvement of gross profit AutoZone’s increasing operating profit indicates the efficiency and profitability of the company Further, the

increase of operating profit led to the slight increase of operating margin, from 17.10% in

2007 to 18.52% in 2011 One financial measure that is strongly related to the stock price

performance is EPS EPS, a key driver of stock price, have been increasing at an extremely high rate From 2007 to 2011, basic EPS have increased for 131%, and diluted EPS have increased for

128% Another important financial measure is PEG ratio PEG ratio is been constantly decreasing, which is a good sign for the company and investors Decrease of PEG ratio signals a greater value for AutoZone’s company, because its investors are going to pay less for each unit of earnings growth Here is a table of financial measures that are related to the stock price:

STOCK PRICE

Aug.25,2007

Aug.30, 2008

Aug 29,

2009

Aug.28, 2010

Aug.27,2011 EPS $120

$138

$149 $8.53

$10.04

$11.73 $211

$298 $14.97

$19.47 EPS

annual

growth

rate P/E RATIO PEG RATIO 17%

17% 13.92

13.61

12.53 0.80

0.73 28%

30% 13.85

14.97 0.49

0.50

AutoZone shareholders had enjoyed strong price appreciation over the previous 5 years (1997-2011), with an average annual return of 11.5% The stock price stood at

$348 in the beginning of the year 2012 From the beginning, AutoZone had invested heavily in expanding its retail footprint via both organic and inorganic growth

In 2008, the U.S economy had gone through the worst recession since the Great Depression, and the recovery that followed had been unusually slow, when the economy struggled and unemployment was high, fewer new cars were purchased, and older cars were kept on the road longer, requiring more frequent repairs As a result, the auto-parts retail business enjoyed strong top-line growth By 2012, AutoZone had become the leading retailer of automotive replacement parts and accessories in the United States.

Besides expanding the scale, AutoZone’s management also focused on after-tax return on invested capital (ROIC) as the primary way to measure value creation for the company’s capital providers and had also developed a sophisticated hub-and-feeder inventory system that kept the inventories of individual stores low as well as reduced the likelihood of stock outs.

Starting in 1998, AutoZone had returned capital to its equity investors through share repurchases The repurchases had been funded by strong operating cash flows and

by debt issuance When a company repurchased its own shares, it enhanced earnings per share by reducing the shares outstanding, and it also served to reduce the book value of shareholders’ equity Shares outstanding had dropped 39% from 2007 to

2011, and shareholders’ equity had been reduced to a negative $1.2 billion in 2011 The net result was that AutoZone’s invested capital had remained fairly constant since 2007, which combined with increased earnings, created attractive ROIC levels This had led AutoZone’s stock price to continuously increase over the previous 5 years.

Companies create value for their owners by investing cash now to generate more cash in the future The amount of value they create is the difference between cash inflows and the cost of the investments made, adjusted to reflect the fact that tomorrow’s cash flows are worth less than today’s because of the time value of money and the riskiness of future cash flows A company’s return on invested capital and its revenue growth together determine how revenues are converted to cash flows That means the amount of value a company creates is governed ultimately by its ROIC, revenue growth, and of course its ability to sustain both over time.

Common stocks are expected to provide a stream of future cash flows, and a stock’s value is found the same way as the values of other financial assets—namely, as the present value of its expected future cash flow stream The expected cash flows consist of two elements: the dividends expected in each year and the price investors expect to receive when they sell the stock The expected final stock price includes the return of the original investment plus an expected capital gain Thus, Financial measures are consistent with stock price performance:

-Cash distribution: companies can distribute cash to shareholders via cash dividends

or stock repurchases Stock repurchases like the situation of AutoZone For cash dividends, because a stock price depends on all future dividends, not just next year’s dividend, increasing next year’s dividend will not have much impact on stock price unless investors expect the dividend increase to be sustainable .

-Free cash flow growth A company’s return on invested capital and its revenue growth together determine how revenues are converted to cash flows That means the amount of value a company creates is governed ultimately by its ROIC, revenue growth, and of course its ability to sustain both over time So in the case that companies’ development growth is greater than expectation return rate of stockholders, companies should keep free cash to invest to get higher profit The companies can use financial leverage to increase their profit

Q#2 How does a stock repurchase work? Why

would a company use

this tactic? What impact does it have on: EPS?

ROIC?

Stock repurchase is one of the methods of returning cash back to its investors A

company buys back its own shares either from marketplace or from their own

shareholders who want to sell their shares Buying a shares back, company is reducing the number of shares outstanding, increasing the shareholders’ value and raising the price of the stock Company can also use

this method to: • prevent a hostile takeover

• cover up poor performance\

• create more attractive financial ratios

• signal the market that the company is strong

• create tax efficient way to return investors’ money

The biggest impact of share repurchasing program is evident in EPS of the company EPS is calculated as Net Income divided by the average outstanding shares Since buying back its own shares is reducing the number of shares outstanding, it

automatically increases the EPS In 2007, AutoZone’s Net Income was $595,672 and the number of shares outstanding was 69,844 This resulted in $8.53 EPS If we

suppose that the income is going to stay the same, but the number of shares

outstanding is going to decrease for 5,000, then we get a higher EPS of $9.19 This is how a share repurchase work It reduces the number of shares outstanding, resulting in improved EPS Share repurchase also affect the ROIC, which is one of the best metrics to

evaluate corporates performance ROIC eliminates much of the non-economic

accounting noise and impacts of financial leverage

AutoZone’s management was very focused on this measurement, because ROIC was a primary way to measure value creation for the company’s capital providers On the balance sheet, a share repurchase will reduce a company’s cash holdings, and therefore reducing the total assets and total shareholders’ equity As a result, ROIC will improve subsequent to a share repurchase Here is a chart that shows the ROIC performance in

the previous five years for AutoZone:

ROIC 2011

41.14% 2010

34.44% 2009

28.64% 2008

25.87% 2007

25.47% The chart shows the strong increase of ROIC It is noticeable that the growth was accelerated from 2008, when the economy recession occurred Together with share repurchase program, this two effect had a large impact

on creating a desirable ROIC Taken all of these into account, AutoZone’s ROIC is indicating that the company offers a strong returns for its investors

Q#3 How much of AutoZone’s stock price performance should we

attribute to the share repurchase program? Share repurchase program is strongly related to the increase of

AutoZone’s stock price Share repurchase program, as mentioned above, reduces the number of shares outstanding, and therefore, creates a strong EPS and increases the price of the stock EPS is one of the most important measures that investors look at because EPS measures company’s

performance In 2007, AutoZone had 69,844 shares outstanding, while in

2011 the number of shares was reduced to 43,603 This led to an increase of 128% in EPS, from $8.53 in 2007, to $19.47 in 2011 Next, the stock price increased from $120 to $298 in the same time period Given the same

capital value for AutoZone Company, more shares outstanding will result in lower share price, while reduced number of shares outstanding will impact the price of a share to grow

Answer:

Corporate value can be calculated by equation:

FCFt

(1 + WACC)t

And stock price can be calculated by:

Stock Outstanding Assuming the other conditions unchanged, AutoZone’s stock price depends on Net Income, because Net Income create the free cash flows (FCF) if the company managed cash flow well Because the company used its free cash flow and debt to repurchase its own stock, so AutoZone’s invested capital had remained fairly constant since 2007 It means that the share repurchase program had not significantly affected

to its FCF.

So that stock price would depend on outstanding stock In terms of AutoZone keeps the ROIC rate, AutoZone’s stock price performance will be correspond to the rate of reduction in the number of outstanding shares.

Q#4 Assume that AutoZone is planning to stop its share repurchase

program What would be the best alternative use of those cash

flows? Why?

If we assume that AutoZone is going to quit its share repurchase

program, the best alternative to use the cash flows would be to expand its

business, either by opening a new stores or by acquisition

The first proposition considers opening a new stores in domestic and

foreign markets The expansion is necessary to override the competition and

1

n

t=

∑

to keep its position of leading retailer of automotive replacement parts and

accessories in the United States Leading retailer position in the U.S gives

AutoZone more motivation to expand overseas AutoZone already owns

some stores outside the U.S., in Puerto Rico and Mexico Those stores have

been operating successfully, giving a company more reasons to continue

with its overseas investments Next AutoZone’s target is Brazilian market

Company’s plan is to expand there over the next several years Overseas

investments can be very profitable for AutoZone, but they also bear a lot of

risk All investments should be developed very carefully, with a high level of

cautions and with expertise person for targeted markets in their

management

The second proposition is growth by acquisition U.S market became

oversaturated with auto part stores in the last couple of years Even though

AutoZone’s management was not seeing any signs of oversaturation at that

time, that doesn’t mean that they will not see it in the near future I believe

there are still some free attractive locations in the U.S., but at some point,

most of the good locations will be covered by the auto parts retail stores, and

the remaining locations would not be a profitable investment Another reason

for acquisition is that such stores would be profitable much more quickly

than it would be opening of a new stores The return time for AutoZone

would be shorten So far, AutoZone has acquired over 800 stores from

competitors

AutoZone also shouldn’t consider temporarily reinvesting its free cash to grow its core business, because:

- The market is likely to be difficult to develop saturation

- The large companies’ high proportion of market share will make merger and acquisition more difficult because it may violate antitrust policy

- The management will be under pressure to expand the scale because AutoZone have not had the managerial capacity to expand that swiftly

- The company has invested in store locations with high profitability, so its expansion will more difficult because there will be only the positions with low profitability

- To develop the overseas market also uncertain: the applicability of the model and risk management of new markets.

Q#5 What should Johnson do about his holdings of AutoZone

shares?

Johnson had one of his largest holdings in AutoZone’s company The

fact that Johnson was concerned about is that Lampert, AutoZone’s main

shareholder, was rapidly liquidating his stake in the company Johnson was

concerned about the future performance of the stock price He was not sure

what the Lampert’s reason for liquidating his stake was This can also have a

negative influence on other investors Lumpert’s liquidation is not necessarily

a bad sign The reason for his liquidation might be the need for funds or

some other personal reasons I believe that Johnson should keep his holdings

in AutoZone’s company

AutoZone’s financial measures indicates that the company is been

constantly improving The most important measures for investors, EPS, ROIC

and stock price, are been increasing at a desirable rates AutoZone’s

investors have been enjoying strong price appreciation, and I believe they

will enjoy it also in the future Lumpert’s liquidation should not affect the

share repurchase program Company should continue with its share

repurchase program even after Lampert liquidates all his stake There is no

signs in financial statements that the company is going to have a decrease in

the stock price AutoZone has created a desirable value for the company

over the long time period and I believe in the continuing future growth of this

company.—

Third, AutoZone’s debt payment ratios was bad This affects its financial security index, and it make AutoZone meet difficult to raise capital in debt to develop or the company had to pay a higher cost of capital.

Fourth, AutoZone is unlikely to maintain a policy of using debt to buy back its own stocks because of its high debt ratios When the company do not have enough capital

to maintain such policies, the ability to its stock price drop would be very high.

Finally, the policy applies to using debt for repurchases create virtual demand in securities market, and the company stock price was probably higher than its instinct value.

AutoZone, the number one auto parts retailer in the U.S., implements Reflexis to

improve its merchandising planning processes and drive consistent store-level

execution

AutoZone is the leading retailer and a leading distributor of automotive replacement parts and accessories in the United States Each store carries an extensive product line for cars, sport utility vehicles, vans, and light trucks, including new and remanufactured automotive hard parts, maintenance items, accessories, and non-automotive products Many stores also have a commercial sales program that provides commercial credit and prompt delivery of parts and other products to local, regional, and national repair

garages, dealers, and service stations AutoZone also sells the ALLDATA brand

diagnostic and repair software On the web, AutoZone sells diagnostic and repair

information, and auto and light truck parts through www.autozone.com

Since opening its first store in Forrest City, Ark on July 4, 1979, the company has joined the New York Stock Exchange (NYSE: AZO) and earned a spot in the Fortune 500 As

of May 2009, AutoZone had more than 4,100 stores in 48 states, the District of Columbia and Puerto Rico in the U.S., and more than 100 stores in Mexico The company was ranked number 148 in the 2009 "Global Powers of Retailing" lis