“Many prefer to invest in a high-growth industry, where there’s a lot of sound and fury. Not me. I prefer to invest in a low-growth industry like plastic knives and forks, but only if I can’t find a no-growth industry like funerals. That’s where the biggest winners are developed…
“In a no-growth industry, especially one that’s boring and upsets people, there’s no problem with competition. You don’t have to protect your flanks from potential rivals because nobody else is going to be interested. This gives you the leeway to continue to grow [and] to gain market share[.]”
-Peter Lynch, One Up On Wall Street
This classic observation from Peter Lynch aptly applies to auto parts retail, an industry which has seen only slow growth the last few decades with retail sales consistently growing below the rate of GDP, and personal consumption expenditures on automobile-related repairs lagging overall consumption expenditures:
Moreover, as cars have become more reliable, last longer, and require less maintenance, the overall expenditure on car-related maintenance is now just a paltry 1.23% of overall consumer expenditures, whereas it was commonly around 2% thirty years ago or so:
I noted in a post last year that the major auto parts retailers such as Advance, AutoZone, and O’Reilly have benefited immensely from this overall industry weakness as they have consistently consolidated market share in this fragmented industry, primarily at the expense of independent shops; J.P. Morgan recently estimated that independent stores have been closing at the rate of about 1.4% per year over the last five years and a whopping 2.65% per year since 2010 [source JPM]:
This growth of the major players can be seen in their per share earnings growth since 2013. Even Advance, generally accepted as the weakest of the large chains grew earnings per share at an above-market rate:
Despite the low growth environment for auto parts retail, it is critical to point out that there is a somewhat unique tailwind to this category which is that the industry is generally cycle-agnostic. Simply put, when times are going well, people drive more, and that generally means more repairs needed to vehicles. On the other hand, when times are tough economically, consumers generally hold onto their cars longer, and that means putting more money into maintenance and repairs as it is cheaper to do so versus buying a new car. It is for this reason that O’Reilly Auto Parts, for example, has posted positive same store sales growth every year since 2000, despite the financial crisis of 2007 – 2009, COVID, and so on:
The economic stability of the industry combined with its overall low-ish growth has allowed the major players to be disciplined with their capital expenditures and prioritize return on invested capital (ROIC) and cash flow returned to shareholders; AutoZone, for example, has kept its capital expenditures between three and five percent of revenues for the last two decades while returning billions to shareholders in the form of share repurchases:
Now that we have discussed all that the auto parts retail industry has going for it, I would like to offer a few opinions on what the future might be in a world where electric vehicles (EVs) – which have far fewer moving parts than internal combustion engine vehicles – constitute an ever increasing share of the motor vehicle fleet.
First of all, it is worth remembering that even though electric vehicles are an increasing percentage of sales it will take years if not decades for them to constitute 40-50% of the overall fleet given that cars last so much longer than previously (something like 10 – 15 years on average), and skepticism on range and ease and speed of charging mean that most households will retain at least one gasoline car until charging infrastructure and technology improve.
Secondly, auto parts retail bears are quick to point out that EVs require no oil changes and spark plugs, and this will put a big dent in sales. This is a little too simplistic in my view; as Canuck Analyst pointed out recently, this segment of sales has been in secular decline for many years now, the result of higher quality synthetic oils, longer last spark plugs, and so on. As vehicle components have trended toward premium quality, the decline in volumes has been more than made up for in pricing, and this trend seems set to continue for at least the foreseeable future.
Thirdly, EVs share many of the same parts that gasoline cars require. For example, I always get a kick out of talking with investors about the topic of EVs and many if not most of them are surprised to learn that a 12 volt battery similar to the one that starts their gasoline car can be found in just about every EV today. I will not get into the technical reasons why EVs require a common lead-acid 12V battery (if interested you can read about that here), but it is worth noting that EVs should expect to put more wear on their starting batteries than gasoline cars do given the more taxing load put on them to start the vehicle.
Along with batteries, EVs share many of the same safety sensors that gasoline cars have. At their most recent analyst day conversation, O’Reilly’s Brad Beckham commented on the growth potential of the sensor category regardless of whether consumers shift to EVs:
In a similar vein, CTS, a company responsible for manufacturing many of the sensors in automobiles today, remarked:
Smart actuators aside, the majority of our portfolio is agnostic to the propulsion system, creating flexibility for us to meet the needs of our customers.
CTS’s IR department provides this useful slide to illustrate what sensors are agnostic to electric vs gasoline, and what new sensors will be needed for EVs:
My final observation is that in a future with predominantly electric vehicles navigating our streets, the increased computerization of vehicles – a recent ride in a Rivian has me convinced that EVs are kind of like smartphones on wheels – will gradually erode the “do it yourself” (DIY) market, and more and more maintenance and repair will be in the “do it for me” (DIFM) category. Even something as simple as a 12V battery change, which in most gasoline cars requires little more than a few minutes seems much more involved if YouTube instructional videos are any indication. Aware of this, EV makers like Tesla would love to capture more of the service side of things if possible, but there is a persistent shortage of available service bays, the result of fewer workers entering the mechanic trade and perhaps the economic upheaval of the financial crisis which shuttered many dealerships, and that capacity has not since returned. This bodes well for the auto parts retailers who cater to the non-dealer mechanic shops who rely on them heavily for speedy delivery of critical parts.
In finishing, it is worth remembering that broad trends in these categories take decades to develop, affording operators ample time to adapt and prepare. It continues to be my personal view that regardless of shifts in technology, the overall dynamics of the industry have not changed, and the major auto parts retailers should continue to consolidate even more of the industry as they prepare to service the car fleet whether it be gasoline, electric, or hybrid.
Disclosure: both the author and clients of Fortune Financial Advisors, LLC own shares of ORLY.
