Autoshack - Autozone Case

Executive Summary

Throughout this report, a case analysis will be conducted over the primary topic of share repurchases and dividends, namely concerning Autozone, Inc. (Autozone) and the strategy for the future use of its cash flows. Within this case analysis, we will examine Autozone's stock repurchasing program, as well as the mechanics behind it and the benefits it provides to the firm. Additionally, this report will analyze the alternative operating cash flow options Autozone should consider, detailing the benefits and costs of each option. A comprehensive examination of these operating cash flow alternatives will be presented, allowing for the determination of the most viable alternative for the use of Autozone's operating cash flows.

General Background of Organization

Founded in 1979 under the name AutoShack, Autozone has grown to become the leading retailer of automotive replacement parts and accessories in the United States, employing nearly 65,000 employees with over 4,800 locations in North America. After changing their name to Autozone in 1987, the company was able to implement the first electronic auto-parts catalogue in the retail industry, helping to establish their dominant position in the market. Because the firm was able to record steady growth for years, it was taken public in 1991, allowing it to be listed on the New York Stock Exchange (NYSE) under the ticker symbol AZO. Along with heavy investments in their retail footprint, Autozone had also developed a refined hub-and-feeder inventory system, keeping in-store inventory levels low while reducing the chance of stock outages. Because of their revolutionary electronic catalogue and their sophisticated inventory system, Autozone was able to develop category leading distribution capabilities, giving them the highest operating margin in the industry. Focusing on return on invested capital (ROIC) as the primary way to measure the firm's valuation, Autozone consistently invests in opportunities that lead to top-line revenue growth, ultimately leading to increased margins. As a way to return capital to their equity investors, Autozone has opted to use a share repurchasing program since 1998. Because of their consistent use of the share repurchasing program since its inception in 1998, there has been a 39% reduction in shares outstanding, reducing shareholder's equity to negative $1.2 billion by 2011. Funded by strong operating cash flows and the issuance of debt, Autozone's share repurchasing program has allowed their invested capital to remain relatively stable, creating an attractive ROIC for the firm (Brenner & Eades, 2012).

Overview of Financial Analysis Tools

In order to fully understand the value that is generated through a stock repurchasing program, it is important to comprehend the financial ratios that will be discussed in this case analysis. (See Table 1.1)

Table 1.1

Financial Ratio | Formula | Use |

Return on Total Assets | Net Income available to CS ÷ Total Assets | Measure of how well management is using its assets to generate earnings |

Return on Common Equity | Net Income available to CS ÷ Common Equity | Stockholders invest in order to garner a return, this tells how well they are doing in an accounting sense |

Price/Earnings Ration | Price Per Share ÷ Earnings Per Share | How much investors are willing to pay per dollar of reported profits |

Earnings Per Share | (Net Income - Preferred Dividends) ÷ Total Shares Outstanding | Portion of a firm's profits allocated to each outstanding share of common stock, a measure of profitability |

Return on Invested Capital | (Net Income - Dividends) ÷ Total Capital | Assesses a company's efficiency at allocating the capital under its control to profitable investments |

Stock Repurchases and the Benefits They Offer

A stock repurchasing program is when a firm buys back its own shares, either from the open market or through a tenant offer, essentially meaning they are choosing to invest in themselves. While many reasons exist as to why firms would repurchase their own shares, two seem to be the most common, the first of which being when the firm believes the market has discounted their shares too much. If this is the case, the firm will opt to repurchase shares from the open market, or through a tenant offer, because they believe their shares are worth more than what the market has dictated, which represents a good investment for the company as a whole. Secondly, a firm might consider repurchasing their own shares in order to improve their financial rations, such as: earnings per share (EPS), return on assets (ROA), return on equity (ROE), and their price to earnings ratio (P/E). In the case of EPS, when the firm repurchases its own shares, the number of shares outstanding is reduced, which results in an increased EPS. Also, when shares are repurchased, assets on the balance sheet are reduced because cash is considered an asset and is used in purchasing the shares, increasing the ROA. In regards to the ROE, when shares are repurchased there is less outstanding equity for the firm, causing the ROE to increase. As well as increasing the ROE, the repurchasing of shares also helps improve the P/E ratio by lowering it, meaning that the firm is considered a less expensive investment. By initiating a stock repurchasing program, a firm is able to improve all of the aforementioned financial ratios, adding value to the firm in the eyes of potential and current investors. In terms of ROIC, the stock repurchasing program will likely leave it unchanged, because as the assets are decreasing the debt is increasing, leaving the ROIC stagnant. Another important benefit offered by a stock repurchasing program is the fact that it is not viewed as "sticky" in the eyes of investors, meaning it is not expected to remain steady or increase from year to year. The implementation of a share repurchasing program allows the firm to vary the amount of shares it repurchases from year to year, making it a more flexible option than the offering of a dividend, which is expected to increase or remain steady from year to year. Because of the perceived benefits offered by a share repurchasing program, they are often used by a firm as an indirect form of dividend that is paid out to shareholders looking to sell their shares (Brenner & Eades, 2012).

Alternative Operating Cash Flow Options

Although Autozone has typically used their operating cash flow to repurchase their own shares, there are several alternative uses for their operating cash flow they may wish to pursue

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