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Why O’Reilly Automotive (ORLY) Stock is a Compelling Investment Case

Alex Smith
·7 mins read

Qualivian Investment Partners recently released its Q2 2020 Investor Letter, a copy of which you can download here. The fund's performance in Q2 was ahead of the S&P 500 by 9.6% and 9.5% on a gross and net basis. You should check out Qualivian Investment Partners' top 5 stock picks for investors to buy right now, which could be the biggest winners of the stock market crash.

In the said letter, Qualivian Investment Partners highlighted a few stocks and O'Reilly Automotive Inc (NASDAQ:ORLY) is one of them. O'Reilly Automotive Inc (NASDAQ:ORLY) is an auto parts retailer. Year-to-date, O'Reilly Automotive Inc (NASDAQ:ORLY) stock gained 6.0% and on August 24th it had a closing price of $463.91. Here is what Qualivian Investment Partners said:

"O’Reilly: ORLY's Q2 2020 results were above even the most bullish expectations. While it began the quarter slowly, it reported same-store sales growth of 16.2%. This was significantly more than the consensus estimate of -2.3%. ORLY’s Do-It-Yourself business was extremely strong in Q2 and outpaced the Do-It-For-Me segment. This performance was impressive even though a key driver of industry demand (miles driven) has been under pressure. The offset was a shift away from public transit, air travel, and ridesharing. ORLY resumed share repurchases in May, highlighting confidence in its liquidity position and outlook.

O’Reilly Automotive (ORLY) is the leading auto parts retailer in the US and it focuses on meeting the needs of two distinct customer segments: the Do-It-Yourself (DIY) customer (57% of sales) and the Do-It-For-Me (DIFM) segment (43% of sales), which is comprised of auto repair shops, service stations and dealers.

The auto parts market (total size of $300 billion with ORLY’s TAM of $100 billion) is still highly fragmented but has been consolidating over the past decade, forming an oligopolistic structure with the top 3 companies representing over 43% of the store counts and the top 5 companies representing 50%. We anticipate that concentration will continue to increase as scale gives the larger players an advantage in terms of distribution, technology, purchasing, and branding.

We believe ORLY can continue to consistently compound earnings growth at a mid-teens plus level for the foreseeable future, leveraging 7%-8% topline growth into low-to mid-teens growth in after-tax earnings, and using their share repurchase program to ultimately deliver mid-teens plus EPS growth over our investment horizon.

Valuation

• ORLY is currently trading at 21.5X NTM5 P/E and 1.0X NTM relative P/E to the market, somewhat richer compared to its historical ranges in absolute terms and quite a bit cheaper on relative terms.

• ORLY has historically traded at a premium to the S&P 500 given its superior growth and return profile: ─ 10-Year average for NTM P/E: 19.8X (with a range of 16.8X to 22.7X at +/- 1SD around the mean). ─ 10-year average for NTM P/E relative to the S&P500: 1.3X (with a range of 1.1X to 1.5X at +/- 1SD around the mean).

ORLY meets our requirements of being a quality compounder: (1) it has sustainable competitive advantage, (2) has good reinvestment opportunities, and (3) has demonstrated excellent capital allocation. More specifically:

Competitive Advantages:

• Founder-Led Culture: the founder’s grandson, David O’Reilly, has been with the company since 1972 where he rotated through all the company’s major business operations, eventually becoming its President and CEO in 1993, before becoming Chairman in 2005, when he gave up day-to-day oversight of the company. Management today carry on the founder’s mantra of putting the customer first above all else and manage the business on that basis.

• Better Distribution System: ORLY pioneered and leads the auto parts industry in building its hub and spoke distribution center, hub and retail store network, giving them an advantage in being able to quickly supply auto parts at industry leading levels of service and product availability.

─ This is key in all retail businesses but especially important in the Professional/DIFM segment, where mechanics need parts within a few hours so that they can reduce their wait times and turnaround their jobs more quickly and improve revenue productivity.

• Higher Customer Satisfaction via Greater Investments in IT:

─ Furthermore, ORLY has been leading the auto parts sector in investing in its Omni Channel capability to expand order fulfillment options for its DIY and DIFM customers via instore, call-in or online ordering channels.

─ COVID has accelerated the investments the company has made in its “Buy Online and Pickup in Store” process which is becoming a key differentiator across the retail space.

Good Reinvestment Opportunities

• Stable End-Market Drivers: Spending on auto repairs and maintenance is relatively stable and predictable and is a function of miles driven, light vehicle population, and fleet age.

• Store Growth: Furthermore, ORLY is underrepresented in key Northeast markets and has been growing store counts organically at a rate of 150-200 stores per year for the last 15 years, which represent roughly 3% to its topline organic growth.

Excellent Capital Allocation

• Opportunistic Acquirer: Typically, ORLY has supplemented its organic store growth via smaller opportunistic acquisitions, however in 2008 it acquired CSK which doubled its store count and gave it the scale to get an order of magnitude improvement in its purchasing leverage from vendors. Given the size and conservativism of its balance sheet, ORLY has the capacity to entertain another sizeable acquisition at the right price to further consolidate the market and improve its positioning within it.

• Share Repurchases: Management returns excess cash flow to shareholders via share repurchases and since the inception of the program in 2011 has bought back a little over 70 million shares, or approximately $13.0bn cumulatively, shrinking the share count by 46%."

Copyright: urfingus / 123RF Stock Photo

In Q1 2020, the number of bullish hedge fund positions on O'Reilly Automotive Inc (NASDAQ:ORLY) stock decreased by about 6% from the previous quarter (see the chart here), so a number of other hedge fund managers don't seem to agree with ORLY's growth potential. Our calculations showed that O'Reilly Automotive Inc (NASDAQ:ORLY) isn't ranked among the 30 most popular stocks among hedge funds.

The top 10 stocks among hedge funds returned 185% since the end of 2014 and outperformed the S&P 500 Index ETFs by more than 109 percentage points. We know it sounds unbelievable. You have been dismissing our articles about top hedge fund stocks mostly because you were fed biased information by other media outlets about hedge funds' poor performance. You could have doubled the size of your nest egg by investing in the top hedge fund stocks instead of dumb S&P 500 ETFs. Below you can watch our video about the top 5 hedge fund stocks right now. All of these stocks had positive returns in 2020.

Video: Top 5 Stocks Among Hedge Funds

At Insider Monkey we scour multiple sources to uncover the next great investment idea. For example, legal marijuana is one of the fastest growing industries right now, so we are checking out ideas like this under-the-radar stock to identify the next tenbagger. We go through lists like the 10 most profitable companies in America to pick the best large-cap stocks to buy. Even though we recommend positions in only a tiny fraction of the companies we analyze, we check out as many stocks as we can. We read hedge fund investor letters and listen to stock pitches at hedge fund conferences. If you want to find out the best healthcare stock to buy right now, you can watch our latest hedge fund manager interview here. You can subscribe to our free enewsletter below to receive our stories in your inbox:

Disclosure: None. This article is originally published at Insider Monkey.