Second Quarter 2015 Results Beat Consensus
O'Reilly Auto Parts (ORLY) reported strong 2Q results today. Comparable store sales increased 7.2% in 2Q, following a 7.2% increase in 1Q. The 2Q revenue ($2.036B) was above street consensus ($1.994B) and above the buy-side estimate ($2.017B). The 2Q EPS ($2.29) also beat street consensus ($2.26). Revenue was up 10.2% over last year's second quarter. Gross margin and operating margin both increased. Gross margin increased to 52.0% from 51.5% a year ago. SG&A, as a percentage of revenue, dropped to 33.1% from 33.3% a year ago. In addition, SG&A included a $19 million one-time, litigation charge. After backing that charge out, adjusted SG&A was even lower at 32.1% of revenue. O'Reilly opened 99 new stores in 1H of 2015, and they are on track to meet their goal of opening 205 new stores. O'Reilly currently operates 4,465 stores, up 4.9% from 2Q of 2014. Sales per sq ft increased 4.8% to $62.74 in 2Q from $59.88 last year. ROIC is well above average at 24.3% over the past year.
O'Reilly increased full year sales guidance to the $7.75B - $7.85B range. This increase is in-line with current expectations after factoring in the 2Q revenue beat. Comparable store sales guidance for 3Q is 3-5%, and full year comp store sales guidance is 4-6%. Lower comp store sales in the second half would be a step down from 7.2% gains in comp store sales during the first half. Gross margin guidance for full year is 51.8% - 52.2%. The mid-point of the gross margin guidance, 52%, is 160 bps higher than the 2014 gross margin of 51.4%. Operating margin guidance is 18.3% - 18.7%, 90 bps higher than 2014. The 3Q EPS guidance is $2.29 - $2.33, and the full year EPS guidance is $8.59 - $8.69, compared to $7.34 and $2.06 in 2014. CapEx guidance is $400M - $430M, and free cash flow guidance is $725M - $775M. The $25.1B market cap and the $750M FCF guidance implies a multiple of 33.5x 2015 FCF.
Pro Forma 2015 - 2017
I see some upside to 2015 revenue. Revenue grew at 10.1% & 10.2% in the first 2 quarters of the year. If I assume a slow-down in the revenue growth to 8% for 3Q and 4Q, that brings full year revenue to $7.87B, up 9.1% from 2014 and slightly above the high end of the revenue guidance. I assume revenue growth of 6.2% & 5.0% in 2016 & '17.
I believe O'Reilly can continue to improve margins through 2017. I assume 52.1% & 52.2% gross margins in 3Q & 4Q which brings full year gross margin to 52.1%, within guidance and 70 bps improvement from 51.4% in 2014. I assume 52.4% & 52.6% gross margins in 2016 & '17. For operating margin, I assume 18.7% & 18.3% in 3Q & 4Q which brings full year operating margin to 18.6%, within management guidance and 100 bps improvement from 17.6% in 2014. In 2016 & '17 I have operating margins of 19.1% & 19.3%.
I see upside to 2015 FCF guidance due to working capital gains in the first half. I assume capex of $415M, $423M & $431M in 2015, '16 & '17. Given all these assumptions and a 36.7% tax rate, I see 2015 FCF of $834M, implying a current valuation of 30.1x 2015 FCF. In 2016, I use a 37% tax rate, and I assume the working capital gains are not repeated which results in 2016 FCF of $722M (34.8x 2016 FCF). In 2017, I again use a 37% tax rate and estimate $779M FCF (32.2x 2017 FCF).
Share Repurchase Program
During 2Q, O'Reilly repurchased $440M of stock. There is currently $649M remaining on the share repurchase authorizations. O'Reilly has repurchased 49.2 million shares of stock since 2011, reducing it's shares outstanding by 32%. O'Reilly has shown impressive and consistent growth in its business. Management has shown their commitment to return capital to shareholders. I believe management has done a great job of capital allocation and business management.
O'Reilly has grown EPS above 20% for 26 consecutive quarters. I see FCF of at least $725M over the next 2-3 years. Given the current stock price of $241.71 ($25.1B market cap), the FCF multiple is 34.6x. This valuation is not excessive in relation to the 20% EPS growth, or 1.7 PEG.
O'Reilly has converted 92% of earnings to FCF over the past year. This is great performance, but my assumption is that some of these working capital gains are non-recurring. As a result, I believe O'Reilly will convert 74% of earnings into FCF going forward. Therefore, the valuation measured as a multiple to earnings is lower then to the valuation measured as a multiple to FCF. The PE multiples for 2015-17 are 27.2x, 24.5x & 22.8x.
I believe the PEG ratio of 2 is a rule of thumb for full value. Therefore, using $725M of FCF and a 40x multiple, I believe O'Reilly to be fully valued at $29B market cap or 16% higher from today's close. My year end price target is $280, and I rate this stock a buy. The $280 price target implies a PE of 31.5x, 28.4x & 26.5x for 2015-17. These multiples seem reasonable to me considering O'Reilly is growing earnings above 20%.
O'Reilly's results are superb! Revenue grew at a 10.1% rate in 1Q and 10.2% rate in 2Q. The revenue growth is expected to decelerate due to tougher comps in the back half. Even if revenue growth is in the high single digits, this growth is still very solid, particularly when compared to multinationals exposed to the stronger dollar who are seeing negative revenue growth. O'Reilly does not have exposure to the stronger USD, and they do not have any China exposure. O'Reilly is executing well. Margins are expanding. Inventory is down. O'Reilly is a great way to play the auto strength and elevated average car age without having to pick an auto OEM or auto parts manufacturer.
Tractor Supply (TSCO) reported solid 2Q results with comparable store sales up 5.6%. Traffic was up 4.2% and ticket was up 1.3%. Margins increased in 2Q This is a good sign after Tractor Supply suffered some margin contraction in 1Q when it had to cut prices to clear high inventory. Total revenue increased 11.9% which beat consensus. Net income grew 14.9%, and EPS increased 17.9%, in-line with consensus.
Tractor Supply did increase guidance for comps, total revenue and earnings for the full year 2015. Comps are expected to increase 3.5-4.5%. Comp growth will be lower in the second half due to tougher year-over-year comparisons. Margins are expected to continue to expand by 10-20 bps in the second half. Low energy costs will be a tailwind to both COGS and revenues.
Revenue growth in 3Q and 4Q is expected to slow to the 9-10% area, and EPS growth is expected to be in the 11-13% area. Tractor supply has no exposure to a strengthening USD. Tractor Supply could benefit from the stronger USD through cheaper imports and a lower price of oil. I also like the fact that Tractor Supply does not have any direct competitors in their target geographies and products.
Tractor Supply has guided 2015 capital expenditures to be $220 - $230 million, up from $161 million in 2014. I see FCF of $278 million in 2015 and $336 million in 2016 (assuming 2016 capex of $332). Relative to a $13.1 billion market cap, this FCF isn't very impressive.
I took a look at Home Depot (HD) and Lowe's (LOW) for a comparison. Tractor Supply has the highest revenue growth rate by a wide margin, 12.2% versus 6.3% and 6.0% over the past 12 months. The forward revenue growth expectations are 8.6%, 4.3% and 4.3%. I see EPS growth of 11.4%, 8.5% and 20.2% over the next 12 months. Lowe's guided to more margin expansion and share repurchases than Tractor Supply and that's how I got the higher earnings growth rate at Lowe's.
All 3 have gross margins in the 34-35% area, but when looking at EBITDA & operating margins, the dispersion is a bit larger at 11-15% and 8-13%. Home Depot has the highest margins based on my numbers. All 3 are benefiting from margin expansion.
The valuation is where the differences become much greater. I see the multiples to forward FCF at 40.2x, 25.7x and 17.6x. Looking at EPS, the valuation is less dispersed, 29.1x, 21.0x and 19.1x.
Tractor Supply has the highest ROIC at 26.3% versus 24.3% and 13.7%. Home Depot and Lowe's both use some financial leverage, 1.1x & 1.5x debt-to-EBITDA, while Tractor Supply has essentially a flat net cash position. Both Lowe's and Home Depot appear to manage working capital more efficiently than Tractor Supply, and both hold a lower number of days of inventory.
To sum it all up, Tractor Supply looks expensive, particularly relative to Lowe's. Of all the above metrics, I think revenue growth is the most important. I also believe Tractor Supply management has some room to improve margins and working capital and inventory. , and I think the revenue growth at Tractor Supply is worth paying up for.
Chipotle (CMG) reported comparable store sales of 4.3% and total revenue up 14.1%. The top line came in a bit below street concensus. Traffice was down -0.3% in 2Q, but management mentioned that traffic is up in July. Management also mentioned targeted price increase in prices of barbacoa and steak items as carnitas comes back to restaurants during 3Q. Chipotle also increased prices in higher cost cities. Chipotle sees very little reaction to their price increases, and they believe they have much more room to raise prices, and I agree with that.
Chipotle said they are on track to open the 190-205 stores in 2015 having opened 98 so far. Management mentioned they would be on the high side or potentially exceed the high end of new store guidance. Comp guidance is low-to-mid single digits, but the return of carnitas and the price increases point to potential upside on comps. Street consensus for revenue growth in 3Q & 4Q is 12-14%. I could see the revenue expectations bumped up to the 14-15% growth area for the remainder of the year. The price increases are going to help, and the new marketing program will increase traffic. Chipotle also mentioned a payment system which it is working on, and this could be a driver of higher traffic in the longer-term.
Margins increased across the board. Gross margins and restaurant level margins increased 70 bps and company-wide operating margins increased 180 bps. Margins were the bright spot of the report. Execution was good in 2Q. Management mentioned a problem in their new scheduling software which would otherwise have decreased labor cost by 30 bps.
Although Chipotle has been a huge success since their spinoff from McDonald's in 2006, I don't think they have marketed their story of natural and healthy food enough. Chipotle recently began a new marketing strategy, and I am hopeful this new marketing can connect to more people. Chipotle is such a differentiated restaurant company, from the non-GMO menu to their restauranteur culture, and their marketing should highlight these differences more clearly, particularly for parents, a potentially under-marketed segment.
2Q EPS was up 27%, and I see EPS growing around 17% over the coming year. The valuation of 35x FCF puts the PEG ratio at 2.0. The longer-term earnings growth assumption could be a bit higher, potentially up toward the 21% area. Although I don't see Chipotle as cheap with a PEG in the 1.7-2.0 area, I do feel the investment is attractive given untapped growth potential through higher traffic and geographical expansion.
Michael Grove, CFA