O’Reilly Automotive, Inc. — Q3 2020 Form 10-Q Summary
Business context and reporting period
O’Reilly Automotive is a specialty retailer of automotive aftermarket parts, tools, supplies, equipment and accessories serving do-it-yourself and professional service provider customers. The filing covers the three and nine months ended September 30, 2020, compared with the corresponding 2019 periods. As of September 30, 2020, the company operated 5,592 U.S. stores in 47 states and 21 stores in Mexico.
Management reported that COVID-19 caused significant sales pressure from mid-March through mid-April 2020, followed by strong demand as stimulus payments, enhanced unemployment benefits, market reopenings and consumers’ increased investment in existing vehicles supported sales through the third quarter.
Financial performance and key metrics
| Metric | Q3 2020 | Q3 2019 | Year-over-year change |
|---|---|---|---|
| Sales | $3.208 billion | $2.667 billion | Up 20% |
| Gross profit | $1.680 billion | $1.423 billion | Up 18% |
| Gross margin | 52.4% | 53.3% | Down 90 basis points |
| Operating income | $725.0 million | $536.4 million | Up 35% |
| Operating margin | 22.6% | 20.1% | Up 250 basis points |
| Net income | $527.3 million | $391.3 million | Up 35% |
| Net margin | 16.4% | 14.7% | Up 170 basis points |
| Diluted EPS | $7.07 | $5.08 | Up 39% |
| Comparable-store sales | Up 16.9% | Up 5.0% | Improved |
| Metric | Nine months 2020 | Nine months 2019 | Year-over-year change |
|---|---|---|---|
| Sales | $8.776 billion | $7.667 billion | Up 14% |
| Gross profit | $4.614 billion | $4.070 billion | Up 13% |
| Gross margin | 52.6% | 53.1% | Down 50 basis points |
| Operating income | $1.885 billion | $1.479 billion | Up 27% |
| Operating margin | 21.5% | 19.3% | Up 220 basis points |
| Net income | $1.359 billion | $1.066 billion | Up 28% |
| Net margin | 15.5% | 13.9% | Up 160 basis points |
| Diluted EPS | $18.12 | $13.63 | Up 33% |
| Comparable-store sales | Up 10.7% | Up 3.9% | Improved |
Q3 sales growth reflected a $441 million increase from comparable stores, $71 million from new and acquired stores, and $32 million from non-store sales. DIY sales increased to $1.869 billion from $1.474 billion, while professional service provider sales increased to $1.265 billion from $1.152 billion.
SG&A increased 8% in Q3 and 5% year to date, but declined as a percentage of sales to 29.8% from 33.2% in Q3 and to 31.1% from 33.8% year to date. Management attributed the improvement primarily to operating leverage and expense controls. Gross margin declined because of prior-year benefits from lower-cost inventory, lower-margin Mayasa sales and distribution inefficiencies caused by unusually high inventory volumes.
Cash flow, liquidity and capital structure
- Net cash provided by operating activities was $2.349 billion for the first nine months of 2020, compared with $1.490 billion in 2019.
- Capital expenditures were $363.4 million, compared with $481.2 million in 2019.
- Company-defined free cash flow was $1.876 billion, compared with $977.4 million in 2019. This non-GAAP measure deducts capital expenditures, excess tax benefits from share-based compensation and tax credit equity investments from operating cash flow.
- Cash and cash equivalents were $1.627 billion at September 30, 2020, compared with $40.4 million at December 31, 2019.
- Total debt was $4.622 billion, including $499.8 million classified as current, compared with $3.891 billion at year-end 2019. Principal debt outstanding was $4.650 billion.
- The company had no borrowings under its $1.2 billion unsecured revolving credit facility at September 30, 2020. Outstanding letters of credit of $66.5 million reduced availability by that amount.
- The company issued $500 million of 4.200% senior notes due 2030 in March 2020 and $500 million of 1.750% senior notes due 2031 in September 2020. On October 14, 2020, it redeemed $500 million of 4.875% senior notes due 2021.
- The company remained in compliance with debt covenants. Its consolidated fixed-charge coverage ratio was 5.80 times against a 2.50-times minimum, and its consolidated leverage ratio was 2.15 times against a 3.50-times maximum.
- The company repurchased 2.634 million shares for $1.094 billion during the first nine months, compared with 3.585 million shares for $1.308 billion in 2019. The program was suspended from March 16 through May 28, 2020, and resumed May 29.
Material changes versus the prior comparable period
- Sales, operating income, net income and diluted EPS increased substantially, driven by strong comparable-store sales, store growth, favorable demand trends and cost leverage.
- Comparable-store sales accelerated to 16.9% in Q3 and 10.7% year to date, despite the earlier COVID-19 disruption.
- Gross margin contracted modestly, primarily due to prior-year inventory-cost benefits, lower-margin Mayasa sales and distribution inefficiencies.
- Cash increased significantly because of stronger operating cash flow, debt issuance and reduced capital expenditures, partially offset by share repurchases and investing activities.
- Debt increased by approximately $732 million from year-end 2019, reflecting the issuance of new senior notes and the company’s liquidity actions during the pandemic.
- The Mayasa acquisition purchase price allocation was finalized in Q3. Identifiable intangible assets included $36.0 million of indefinite-lived trade names and trademarks and $25.5 million of finite-lived intangible assets; residual goodwill was $73.4 million.
- The company adopted the current expected credit loss accounting guidance in Q1 2020, with no material impact on financial condition, results of operations or cash flows.
Guidance, outlook, commentary and risks
- Management estimated approximately 165 net new store openings in 2020. No specific revenue, earnings or comparable-store-sales guidance was provided in the filing.
- Management remained confident in the company’s ability to gain market share and expand, supported by its dual-market strategy, customer service, inventory availability and an aging vehicle fleet.
- The company could not predict the duration or severity of COVID-19, the future effects of government stimulus, changes in reopening policies, consumer behavior or broader economic conditions.
- Key risks include renewed store restrictions, reduced vehicle miles driven, weaker consumer demand, disruption to suppliers and inventory deliveries, labor and operational disruptions, increased debt, covenant compliance, competition, cyberattacks, foreign currency exposure and risks associated with acquired businesses.
- The company reported ordinary-course litigation but did not believe the aggregate exposure, after insurance and accruals, would materially affect its financial position, results of operations or cash flows.
- Subsequent to quarter-end through November 6, 2020, the company repurchased an additional 1.0 million shares for $465.3 million. The filing also disclosed the October 2020 redemption of the $500 million senior notes due 2021.
Most important facts for investors to verify
- Whether the unusually strong COVID-era demand and comparable-store sales growth persisted after government stimulus and enhanced unemployment benefits ended.
- The sustainability of operating-margin expansion given the lower gross margin, distribution-cost pressures and potential normalization of sales.
- Debt maturities, refinancing requirements and the effect of higher debt and lease obligations on future cash flow.
- The company’s continuing share repurchase pace and its impact on liquidity, leverage and share count.
- Actual 2020 store openings versus the approximately 165-store estimate and the performance of the Mayasa acquisition.
- Potential supply-chain disruptions, reduced miles driven, renewed pandemic restrictions and other COVID-19 effects on DIY and professional customer demand.