Value Investing Congress Blog

A company I have followed on and off is O’Reilly Automotive ( ORLY )—the (previously) regional auto parts retailer.  Given the struggles retailers of all kinds are having, and expected to continue having in the short- to mid-term, Mr. Market has trimmed almost 25% off O’Reilly’s market price since the beginning of the year.
Why am I interested in O’Reilly now?  Well, the company is also undergoing fundamental change: it’s acquiring another regional player—CSK Auto—for approximately $1 B, including the assumption of debt.  The acquisition will give O’Reilly a little over 3,200 stores and puts that number within spittin’ range of Advance Auto Parts (approximately 3,300 stores) and AutoZone (approximately 4,200 stores).  O’Reilly has already arranged to refinance CSK’s debt at what-should-be a lower rate with corresponding interest expense savings.  O’Reilly also forecasts $100 MM in cost savings beginning in 2010 through increased buying power juicing gross margins and streamlining CSK’s SG&A to firm operating margins up to O’Reilly’s level.

The CSK acquisition is similar in relative-size as O’Reilly’s acquisition of Hi/Lo in 1998, so I’ve spent some time reviewing the Hi/Lo precedent.  Here are some of the more relevant data points:

• The CSK acquisition moves O’Reilly from a leading regional auto parts retailer into a larger national footprint with a big move into California . AutoZone has approximately 430 stores in California .  After the CSK acquisition, O’Reilly will have 500 stores in California .
• The Hi/Lo acquisition also gave O’Reilly 7 stores in California which O’Reilly chose to divest rather than hang onto as a toehold in a growth-at-any-cost effort.
• In 1997 AutoZone had 264 stores in Texas ; 382 after its 1998 acquisition of Chief Auto Parts.  O’Reilly’s  Hi/Lo acquisition moved the company into Texas —where 25% of all      O’Reilly stores were located at the end of 2007.
• O’Reilly has continued its Midwestern regional success even with the continuing outsized exposure to Texas .  I believe O’Reilly’s management will be similarly successful in the assimilation of Southwestern and California stores from the CSK  acquisition and prudent in its choice and timing of store branding  conversions.

Keep in mind that CSK’s total cash cost will ultimately end up being higher than the $1 B due to investments in CSK’s distribution centers and store conversions, but a quick back-of-the-envelope calculation puts the combined entity’s Total Enterprise Value (TEV) around $4.2 B with LTM EBITDA around $470 MM—before the $100 MM in cost savings and margin improvements.  Based on this simple estimate of $570 MM for 2010 EBITDA, O’Reilly is currently trading at less than 7.5x 2010e EBITDA.

There are a number of macro concerns (increasing gasoline costs, decreasing mileage driven, increasing manufacturer pricing power, etc.) when looking at O’Reilly, so additional research is crucial to any decision.