Auto Parts Retailers in Overdrive

Shares of automotive parts retailers like AutoZone (AZO) and O'Reilly Automotive (ORLY) continue to surge to record heights, as consumers who have held off buying new cars spend more to maintain their old models.

From 2000 to 2007, new car sales averaged 16.8 million per year in the U.S., according to Commerce Dept. data. By contrast, on Nov. 3, new data showed cars and light trucks were sold at a seasonally adjusted annual rate of 12.25 million in October, up from 11.73 million in September. The worst of the sales slowdown was a 35 percent drop from 2007 to 2009, when the 10.4 million vehicles sold were the lowest total since 1982.

As Americans buy fewer new cars, they are spending more to maintain existing vehicles, analysts and executives say.

Same-store sales at O'Reilly, the second-largest U.S. parts retailer by number of locations, surged 11.1 percent year-over-year last quarter. The company based in Springfield, Mo., has boosted its store count from 3,415 to 3,536 since a year earlier, when same-store sales were also up handily, rising 5.3 percent year-over-year.

"Our industry clearly continues to benefit from the tailwinds that have been present for some time now," O'Reilly Chief Executive Officer Gregory Henslee told analysts when those results were announced on Oct. 28. "The average age of vehicles driven in the U.S. continues to increase as new vehicle sales have stalled," he said in a conference call.

Peak Growth

For automakers and new car dealers, "it has been a slow, disappointing recovery," says Wells Fargo (WFC) analyst Matt Newer. "It's taken longer than we all would have expected to come back."

By contrast, the good news for retail auto parts stores keeps arriving, surprising industry experts like Morningstar (MORN) analyst Zoe Tan. "They're at their peak [in the] business cycle," she says. "Eventually, the pace of growth will decelerate to a more moderate level."

AutoZone, the U.S.'s largest auto parts chain, reported a 9.5 percent rise in its fourth-quarter total sales on Sept. 21. Same-store sales rose 6.7 percent, and 160 stores were added to the 4,389-store chain from a year earlier. Advance Auto Parts (AAP), which reports quarterly results on Nov. 10, is expected to post a 7.3 percent increase, according to analysts surveyed by Bloomberg.

Alan Tarver, fund manager at Frost Investment Advisors, owns shares of O'Reilly, saying he believes the industry's sales growth can continue.

"The question for 2011 is how much longer does this last," Tarver says. New car sale trends have improved, with October new vehicle sales at their fastest pace in 14 months. Through October, 9.55 million cars and light trucks have been sold in the U.S., compared with 8.6 million at this point last year.

Stock Records

O'Reilly's recent results for the quarter ended Sept. 30—which included a 13.3 percent year-over-year jump in sales—"makes me think we have a little further to go," Tarver says.

Other investors apparently agree. AutoZone and Advance Auto Parts shares both hit records on Nov. 4, with AutoZone up 51 percent in 2010 and Advance Auto Parts 62 percent higher year-to-date. O'Reilly's stock hit a record on Oct. 29, and is up 52 percent this year through Nov. 4.

Shares of Pep Boys – Manny, Moe & Jack (PBY), which is the U.S.'s fourth-largest retail auto parts chain, have risen 43 percent year-to-date.

The auto parts retailers have helped make auto retail this year's top-performing industry index in the Standard & Poor's 500-stock index, up 59 percent in 2010 compared with 9.5 percent for the broad large-cap benchmark. AutoZone and O'Reilly Automotive are members of the industry index along with auto dealers AutoNation (AN) and CarMax (KMX).

Both those dealers have benefited from increasing used-car sales. CarMax, which specializes in used cars, said the number of used vehicles sold rose 5 percent in the quarter ended Aug. 31. In the quarter ended Sept. 30, AutoNation, the largest U.S. automotive retailer, saw its used-vehicle sales count rise 25.4 percent from a year earlier—while the number of new vehicles sold increased 3 percent.

Americans are holding on to new cars for an average of 5 years and 3.9 months, which is 4.5 months longer than a year earlier, according to estimates from researcher R.L. Polk & Co. The firm said in a Nov. 3 announcement that the average length of new-car ownership has risen 14 percent since the end of 2008—"with no signs of slowing down."

"Echo Boom"

More old cars on the road mean more need parts replaced. Robert W. Baird analyst Craig Kennison estimates cars 8 to 11 years old need batteries at four times the rate of cars that are 3 years old or younger. In older vehicles, headlamp bulbs need replacement at three times the rate and wiper blades at twice the rate of younger cars. "In effect, we expect the credit bubble that fueled a new-car boom from 1999 [to] 2005 to drive an echo boom benefiting auto parts retailers," Kennison wrote Oct. 28.

Another factor helping auto parts retailers is the relatively low and stable price of gas, which encourages drivers to put more mileage on their cars, Kennison said. According to AAA, formerly known as the American Automobile Assn., the average price of regular unleaded gasoline is $2.80, compared to $2.69 a year earlier.

The poor state of the new car market caused a 3.7 percent drop in the number of auto dealers in the U.S. in 2009, according to Kennison, a trend that has shifted more repairs to independent shops that use the national retail chains as suppliers. Dealers tend to buy parts from automakers or other wholesale suppliers.

Large national auto parts dealers have been taking market share from local and regional players, Morningstar's Tan says. Still, the auto parts retail business is still fragmented. She estimates the five largest auto parts retailers make up only about 30 percent of the total parts market.

Henslee, the O'Reilly CEO, said he believes Americans have gotten used to driving cars for a longer period of time. Vehicle quality has improved and now many cars can be driven for 200,000 miles or more without major issues. Thus, he said, favorable conditions for the industry "could be long-lasting, as consumers permanently change their behavior, and gain comfort with driving well-maintained vehicles at higher mileage."

Mark Mandel, an analyst at ThinkEquity, warns that eventually favorable trends could reverse. "If the economy were to accelerate and new car sales were to accelerate, you could get the tailwind becoming a headwind," Mandel says. That "doesn't seem to be imminent, but it's something that bears watching."

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