Thursday, May 26, 2005

A Tale of Two Companies

This about two companies: each is a mature, publicly-traded retail-related entity having a long history of operating several thousand stores, with veteran management overseeing a store culture of customer service and deep product knowledge.

But the similarities end there.

Company A is a financial marvel. It generates a 50% gross margin, 19% operating margin and a 14% return on assets—in an industry where a 45% margin, a 10% operating margin, and high single-digit return on assets are considered exceptional.

So tight-fisted and bottom-line focused is management that Company A never invests in a project that does not provide a minimum 15% return on capital. Consequently, Company A generates surplus cash flow with which it routinely buys back stock.

Company B, on the other hand—remember, each operates in the exact same business—is an operational weakling. It generates negative same-store-sales (the standard industry measure of retail growth), in good times and bad—and blames all manner of outside factors for the poor store results, rather than its own business practices.

Indeed, Company B is losing market share at an increasing rate: the gap between its own same-store-sales and that of its competitors has been widening, virtually quarter-by-quarter, for two and a half years.

Back in the December 2002, Company B’s same-store-sales were lagging its largest competitor by 2%. This past quarter, that same gap had exploded to 14% as Company B’s same-store-sales dropped 5% while its largest competitor’s jumped 9%.

In fact, Company B’s total sales, including new store openings, declined 1.6% last quarter, while that same large competitor grew total sales by 12%.

Who are these companies—Company A and Company B—and in what business do they operate?

They are one and the same company: they are Autozone, the largest specialty retailer of do-it-yourself auto parts and supplies.

Tomorrow we will explore the two faces of Autozone in greater depth, to see how a retailer’s financial success can not only mask its operational weakness, but, in the long run, be its own worst enemy.

Jeff Matthews
I Am Not Making This Up

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.

1 comment:

Mithrophon said...

The question is, will former AZO CEO Steve Odland take the same act with him to Office Depot? Or did large AZO shareholder Eddie Lampert and the AZO Board of Directors control Odland and keep him from implementing his own ideas?

ODP's margins are significantly below its competitor Staples', and while some of that is structural and unlikely to converge, there still is enough operating leverage to theoretically drive large financial improvements at ODP.

It all depends on whether Odland brings the AZO culture with him. ODP's BoD has historically preferred to shepherd cash for growth acquisitions and has only recently implemented a share repurchase, so this could be a very interesting strategic evolution to track.