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AutoZone: Hold On to This Recession-Proof Stock

The U.S.-China trade war resulted in the value destruction of some of the best-performing stocks, which resulted in the need for investors to find more resilient, recession-proof options to add to their portfolios. Companies in price-insensitive sectors involving non-discretionary consumer spending have become the best bet when it comes to such resilience. One of the best examples of such a fundamentally strong investment opportunity today is auto parts retailer AutoZone Inc. (NYSE:AZO).

What does AutoZone do?

AutoZone is a known retailer and distributor of auto parts. The company has a wide variety of products for daily auto use as well as maintenance, which includes everything ranging from spark plugs to seat covers, compressors, batteries, bearings, belts, thermostats, fuses, wires and so on. The Memphis, Tennessee-based auto parts giant also has a software business line, which includes the sale of automotive diagnostic and repair software under the ALLDATA brand through alldata.com and alldatadiy.com. AutoZone has over 5,000 stores in the U.S. alone and a strong presence in Mexico (over 600 stores) and Brazil (around 35 stores).

Strong performance across retail and commercial segments

AutoZone delivered solid quarterly results, beating analysts' earnings and revenue expectations for the third time in a row. The company reported revenue of $2.79 billion, which was above the analyst estimate of $2.76 billion and also a significant improvement over the $2.64 billion reported in the prior-year quarter. All three core business lines drove this revenue growth, with commercial sales increasing 14% on a year-over-year basis.

The stores business was also on track as the company opened about 18 stores during the quarter, with good performance in Mexico and Brazil. At the retail level, management is looking to provide better parts coverage and more variety while controlling inventory levels, which is key for the company's future success. Despite the period being one of the slowest times of the year for auto parts, the company reported an improvement in earnings per share. The reported number of $14.3 was not only above the analyst consensus estimate of $13.74, but well above the earnings of $13.47 per share recorded a year ago.

Why auto parts is a solid industry

The purchase of auto parts falls under the non-discretionary spending activity of consumers. As a result, the industry has a very strong cushion protecting itself from economic downturns. This is the reason why players like AutoZone, O'Reilly (NASDAQ:ORLY) and Advance Auto Parts (NYSE:AAP) have continued to be solid despite the U.S.-China trade war. Most of these companies depend on the domestic consumption and the nature of the U.S. consumer is relatively prince insensitive in this regard.There has also been a visible slowdown in manufacturing activity in the U.S. lately, which is expected to pass on to the demand as well. However, companies like AutoZone, which are involved in the sale of non-discretionary goods, might actually benefit from the trend as people not buying new cars would actually end up spending more on maintaining their existing vehicles. This makes the stock truly recession-proof.

AutoZone versus the competition

The chart above depicts the price movements of AutoZone and its two biggest competitors, O'Reilly and Advance Auto Parts. While 2019 has been a rough year for companies hit by the trade war, AutoZone climbed 45%, O'Reilly gained 29% and Advance Auto Parts has been flat, which is a decent performance overall.

While it may have been at the top in terms of stock performance, AutoZone is a close second to O'Reilly in terms of operating margin and revenue growth.

AutoZone's operating margin of 18.55% is marginally below O'Reilly's margin of 19.11%. Also, O'Reilly's three-year annualized revenue growth rate of 13.9% is above that of AutoZone's 10.1%. While O'Reilly is consistently trading at a higher enterprise value-to-revenue multiple as compared to AutoZone and Advance Auto Parts (which is well below both companies on both metrics), it also means that AutoZone has scope for multiple expansion, which is definitely good news for its investors.

Key takeaways

AutoZone may be recession-proof, but investors have to watch out for a number of factors, including the company's margin evolution, the success of the omnichannel strategy, store growth across the U.S., Mexico and Brazil and the revenues generated from its online business. Joel Greenblatt (Trades, Portfolio) adding to his position in AutoZone is certainly another positive in the stock's favor. Overall, the stock is worth holding on to and sitting tight while the company handles the economic turmoil with ease and comes out a winner.

Disclosure: No positions.

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This article first appeared on GuruFocus.