What does O‘Reilly do?
O’Reilly is one of the largest retailers of automotive aftermarket parts in the U.S. They sell products to both do-it-yourself (“DIY”) and professional service providers. The business was founded in 1957 and initially operated from a single store in Springfield, Missouri.
O’Reilly’s stock has returned over 60x in the last 20 years and over 8x in the last 10 years.
As of the end of 2021 O’Reilly operated 5,759 stores in 47 states in the United States and 25 stores in Mexico.
O’Reilly holds a high number of SKUs at its stores and distribution centers, this is a huge competitive advantage. Professional service providers, which account for 41% or revenue, usually consolidate to the supplier that has the most parts and can deliver the fastest.
On average a U.S. store carries approximately 21,000 SKUs and averages approximately 7,500 total square feet in size. O’Reilly currently operates 28 regional distribution centers, which provide their stores with same-day or overnight access to an average of 158,000 SKUs, many of which are hard-to-find items not typically stocked by other auto parts retailers. They operate a total of 375 Hub stores that also provide delivery service and same-day access to an average of 45,000 SKUs from a Hub or 80,000 to 92,000 SKUs from a Super Hub to other stores within the surrounding area.
The automotive aftermarket industry includes all products and services purchased for light and heavy-duty vehicles after the original sale. The total size of the automotive aftermarket is estimated to be approximately $325 billion, according to The Auto Care Association. This market is made up of four segments:
- Work done by professional service providers
- Auto parts sold to professional service providers
- DIY sales
- Tire sales
O’Reilly estimates its addressable market within this industry at approximately $130 billion to $140 billion. They do not sell tires or perform for-fee automotive repairs or installations.
The automotive aftermarket industry is still highly fragmented. As a result of their dual market strategy, they are able to profitably operate in both large, densely populated markets and small, less densely populated areas that would not otherwise support a national chain selling primarily to the retail automotive aftermarket.
Key drivers for aftermarket parts are:
- Number of U.S. miles driven
- Number of U.S. registered vehicles
- New light vehicle registrations
- Average vehicle age
As the average age of vehicles on the road increases, a larger percentage of miles are being driven by vehicles that are outside of a manufacturer warranty. These out-of-warranty, older vehicles generate strong demand for automotive aftermarket products as they go through more routine maintenance cycles, have more frequent mechanical failures and generally require more maintenance than newer vehicles.
O’Reilly purchases automotive products in substantial quantities from over 685 suppliers, the five largest of which accounted for approximately 25% of the total purchases in 2021. The largest supplier in 2021 accounted for approximately 8% of the total purchases and the next four largest suppliers each accounted for approximately 3% to 6% of the total purchases.
O’Reilly has a very experienced leadership Team. As of December 31, 2021, the company had 229 senior managers who average 20 years of service, 289 corporate managers who average 16 years of service and 574 district managers who average 14 years of service. The institutional memory these people have is invaluable.
Historically the company has been able to pass along increases in its acquisition costs through higher retail prices. The company believes that inflation doesn’t have a material affect on its business.
O’Reilly’s margins are best in class, and it has consistently improved them over the last decade. Gross margin grew from 50.1% in 2012 to 52.7% in 2021, Operating margin grew from 15.8% to 21.9% and net income margin grew from 9.5% to 16.2%. Clearly the company is good at optimizing its operating leverage.
The COVID boost
The company has consistently generated operating cash flow of about 16%-18% of revenue until the pandemic, during which operating margins grew to ~24%.
During the last decade, the company has worked hard to grow its accounts payables as a percentage of inventory so that it doesn’t need to fund the inventory on the balance sheet through its own working capital. 2016 saw its accounts payable grow to around 105% of inventory where it stayed until 2020 when COVID hit. During COVID, suppliers extended their payment terms and accounts payable grew to 127% of inventory in 2021. This allowed the company to grow its cash flow materially, the company basically sold inventory and expanded the time it took to pay its suppliers for this inventory. As of 2022 Q3 Accounts payable were at 134.7% of inventory.
🚨 Back to normality
Now that the world is returning to pre-COVID, my belief is that we will see accounts payable return to their previous numbers, and that operating cash flow as a percentage of revenue will return to the 16%-18% range. My plan is to continue following the company and watch for any changes in its accounts payable vs. inventory.
Same Store sales:
Same store sales is also something to watch after growing strongly during the pandemic.
Historicly the P/E multiple has been range bound between 14x to 23x, we are currently at the 23x multiple which seems a bit high if their financials normalize.
O’Reilly has been quite the cannibal, it has been aggressively buying back its stock and its share count has been cut almost in half in the last 10 years. In a world of SBC dilution this really stands out.
Thank you for reading, I hope you found this article useful.
Disclaimer: This article does not represent investment advice and is solely the author’s opinion. The author is not a financial advisor. Readers are expected to perform their own due diligence before making investment decisions. Full Disclaimer
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