O’Reilly Automotive Gets Cheaper, But Is It Cheap Enough?

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I’ve oscillated in the past on O’Reilly Automotive (NASDAQ:ORLY) between “bearish” and “cautious”, with the former coming into play more recently. I’ve found the valuation of ORLY to be absolutely outrageous despite its outstanding performance and that alone has been enough to turn me off from the stock. ORLY is the best operator in what used to be a very hot sector of retail. It still is hot – for ORLY – but for how much longer? At 22 times this year’s earnings following another outstanding report, it certainly isn’t cheap. But has the stock consolidated enough to finally be worth a look from the long side?

Sales were up 8% yet again in Q4 as ORLY continues to open new stores, but more importantly, its comp sales remain elevated. ORLY has increased same store sales for 24 consecutive years and 2016 was as impressive as any other. Comps were up 4.8% in Q4 on top of better than 7% in last year’s Q4, a staggering result. ORLY has continued to surge with respect to comp sales where others haven’t and has continued to show it is the best of breed. But higher and higher comps don’t just boost sales, they boost margins as well and ORLY ran those up in Q4 too.

Gross margins were up 40 bps in Q4 as higher leverage from comp sales continues to produce efficiencies in the supply chain. SGA costs followed suit and also leveraged 40 bps, meaning that operating income jumped from 18.6% to 19.4%. That’s an extraordinary level of operating income from a retail business and it is yet more proof ORLY is the best of breed. But that has been the case for some time and I’ve still thought the stock is expensive; so has anything changed?

ORLY’s dominance in the auto parts retail space is unquestioned and you can do worse than to buy the best of something. But if we look at the chart for the past 15 months or so, ORLY is at nearly the same level it was in November of 2015. That seems like ages ago, but ORLY spent the whole of 2016 bouncing around. It did plenty of that, but unless you were a frequent trader, you’re in the same spot you were in 15 months ago. This, despite the fact that EPS rose by 17%. That has done a lot to remedy the overvaluation I’ve been incessantly mentioning with respect to ORLY, and I’ll admit the lower valuation does intrigue me. But I have concerns as well, and they are large enough that I’m still landing on the cautious side.

First, the technical picture doesn’t look great. The stock topped out above $290 a few months ago and hasn’t made any sort of attempt to retake that level. The momentum indicators are validating that the rally is losing steam and the 200DMA is in very serious danger of rolling over. It would take a few more weeks of weak price action to get there, but it certainly looks like the base case from here. That scares me as it makes me think the big money buyers aren’t around any longer, and I’m wondering who is going to power the stock higher. After all, at 22 times earnings, it isn’t a value stock, but it isn’t commanding the outrageous growth multiple it once did either.

Second, Amazon (NASDAQ:AMZN) is taking over the world in every conceivable way, and with its same-day delivery capabilities already well built and drones on the way, I wonder if the convenience of ORLY and other auto parts stores will lose its luster over time. After all, if you’re working and don’t have to stop to go to the store, that’s a huge win. ORLY and others can command huge margins because they offer hard-to-find items at a moment’s notice. The consulting piece of the business is something Amazon can’t replace, but I wonder just how much Amazon could eat into this business over time. And of course, Amazon doesn’t care about making money, so anytime it gets into a business in a big way, it is terrible news for incumbents. This isn’t an ORLY-specific problem, but it matters all the same.

I’m not trying to sound overly bearish, but even if ORLY continues to do 13% to 15% EPS growth, it is still going for better than 1.5X its growth rate. That’s far cheaper than it has been in the recent past, but the technical picture does worry me. There’s no doubt ORLY is the best at what it does and no valuation would change that. But with the looming threat of Amazon also over its head, I’m still on the sidelines. ORLY will continue to grow, continue to buy back stock and impress in every way. At this price, however, there’s a bit too much uncertainty for me to jump in. On a meaningful pullback, where I could get it around or under 20 times earnings, I’d be on it. Q4 was further affirmation that ORLY really is that good; it just isn’t quite there yet for me.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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