Fitch Affirms AutoZone's IDR at 'BBB'; Outlook Stable
KEY RATING DRIVERS
The rating reflects AutoZone's leading position in the retail auto parts and accessories aftermarket, its consistent operating performance, and steady credit metrics. The ratings also consider the company's aggressive share repurchase posture with the company managing leverage in the mid-2x over the last few years and using excess cash and debt to fund share repurchases.
AutoZone is a leader in the large, growing and fragmented auto parts aftermarket. AutoZone competes in two markets. It is the number one player in its primary sub-sector, the $54 billion 'Do-It-Yourself' auto aftermarket (approximately 80% of AutoZone's sales) and a small but growing player in the $67 billion 'Do-It-For-Me' commercial auto aftermarket. Both the 'Do-It-Yourself' and 'Do-It-For-Me' segments have grown 2% - 3% annually and are expected to continue growing at this rate. Approximately 85% of AutoZone's merchandise mix consists of either maintenance or replacement of failed products, for which demand is relatively stable.
The company's sales have been resilient to both discount and online competition. Discounters have not invested in growing their auto parts sales due to the inventory investment required to fully serve customers (across auto manufacturer, part, and model year) which results in low inventory turns. While online penetration has grown over time to around 5% of total industry sales, Fitch believes the bricks-and-mortar industry is somewhat protected due to the combination of high-touch service, purchase immediacy, low average ticket and restrictions on shipping for key items (i. e. batteries).
In addition, AutoZone benefits from a still-fragmented industry, with the top five players in the combined retail/commercial space holding around 30% U. S. market share. Independent players, which continue to hold significant market share, have struggled as players such as AutoZone open stores with a larger inventory investment and ramp relationships with retail and commercial customers. This dynamic has permitted AutoZone to gain share over time without engaging in unhealthy price competition.
As a result of the benign competitive environment, comparable store sales (comps) have averaged 3.3% over the past five fiscal years, and were 3.8% and 3.0% in fiscal 2015 (ended August 2015) and the first three quarters of fiscal 2016, respectively. Comps have weakened modestly in recent quarters, due in part to a mild winter, which limited auto parts failures, and a rainy spring across parts of the country, curtailing miles driven.
Going forward, Fitch expects AutoZone can sustain low single digit comps supported by 1% - 2% comps on the retail side of the business and relatively faster growth in the commercial business. Overall sales growth should be in the mid-single digits due to the addition of around 200 units annually.
AutoZone has among the strongest operating margins in the retail sector. The company's size, national footprint (it owns around half of its real estate), and retail-orientation have contributed to its industry leading EBITDA margin of 22.4% in the twelve months ending May 7, 2016. Fitch expects EBITDA margins to remain in the 22% - 23% range over the next few years, as fixed-cost leverage is mitigated by increased mix of lower-margin commercial sales and rapid replenishment efforts to reduce out-of-stocks.
AutoZone's credit metrics have been stable with adjusted debt/EBITDAR ratio (capitalizing operating leases on an 8x gross rent)at 2.7x over the past four years, reflecting an aggressive share buyback program.
Fitch expects AutoZone will generate free cash flow (FCF) of around $900 million - $1.1 billion annually over the next three years. Excess free cash flow, together with some incremental borrowings, is expected to be directed towards share buybacks. Overall debt is expected to grow in line with EBITDAR, enabling the company to maintain its current leverage profile.
KEY ASSUMPTIONS
--Fitch expects AutoZone can sustain low single digit comps supported by 1% - 2% comps on the retail side of the business and relatively faster growth in the commercial business. Overall sales growth should be in the mid-single digits due to the addition of around 200 units annually.
--EBITDA margin should remain in the 22% - 23% range, as fixed-cost leverage is mitigated by a gradually increasing mix of lower-margin commercial and online sales;
--Free cash flow of $900 million - $1.1 billion annually which will be directed towards share buybacks;
--Debt levels are expected to grow in line with EBITDAR, enabling the company to maintain its current leverage profile.
RATING SENSITIVITIES
A positive rating action could be driven by stronger than expected operating results with a commitment by management to manage adjusted leverage in the low to mid 2x area.
A negative rating action could be driven by softer operating results, including sales growth that trails the industry, a FCF margin below 8% - 10% and/or an EBITDA margin below 20% for an extended period, or more aggressive share repurchase activity resulting in an increase in adjusted debt/EBITDAR to the low 3x area.
LIQUIDITY
AutoZone has adequate liquidity. The company maintains a $1.25 billion five-year revolving credit facility and a $500 million 364-day facility, primarily to support commercial paper borrowings, letters of credit and other short-term unsecured bank loans. The available balance is reduced by commercial paper borrowings and certain letters of credit. As of May 7, 2016 AutoZone had $681 million in available capacity. Combined with readily available cash of $213 million, total liquidity amounted to $894 million.
FULL LIST OF RATING ACTIONS
Fitch has affirmed AutoZone, Inc.'s ratings as follows:
--Long-Term Issuer Default Rating (IDR) at 'BBB';
--Senior unsecured debt at 'BBB';
--Bank credit facility at 'BBB';
--Short-Term IDR at 'F2';
--Commercial Paper at 'F2'.
The Rating Outlook is Stable.
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