A Quality Exec Comp Plan Lowers The Risk Of Investing In AutoZone

One new stock makes April’s Exec Comp Aligned with ROIC Model Portfolio, available to members as of April 14, 2022.

Recap From March’s Picks

The Exec Comp Aligned with ROIC Model Portfolio (-2.9%) underperformed the S&P 500 (+0.6%) from March 16, 2022, through April 12, 2022. The best performing stock in the portfolio was up 10%. Overall, five out of the 15 Exec Comp Aligned with ROIC Stocks outperformed the S&P 500 from March 16, 2022, through April 12, 2022.

This Model Portfolio only includes stocks that earn an attractive or very attractive rating and align executive compensation with improving ROIC. I think this combination provides a uniquely well-screened list of long ideas because return on invested capital (ROIC) is the primary driver of shareholder value creation.

New Stock Feature for April: AutoZone Inc.

AZO

AutoZone Inc. (AZO) is the featured stock in April’s Exec Comp Aligned with ROIC Model Portfolio. I made AZO a Long Idea in February 2014. Since then, the stock is up 308% vs. +143% for the S&P 500.

AutoZone has grown revenue and net operating profit after tax (NOPAT) by 6% and 9% compounded annually, respectively, over the past ten years. See Figure 1. The company’s NOPAT margin rose from 12% in fiscal 2011 (FYE is 8/28/22) to 17% over the trailing twelve months (TTM), while invested capital turns improved from 1.9 to 2.1 over the same time. Rising NOPAT margins and invested capital turns drove the company’s ROIC from 23% in fiscal 2011 to 36% TTM.

Figure 1: AutoZone’s NOPAT & Revenue Growth: Fiscal 2011 – TTM

Executive Compensation Properly Aligns Executive Incentives

AutoZone’s executive compensation plan aligns executives’ interests with shareholders’ interests by tying executives’ annual cash bonuses to the company achieving a target ROIC.

AutoZone’s inclusion of ROIC as a performance goal has helped create shareholder value through rising ROIC and economic earnings. AutoZone’s ROIC improved from 22% in fiscal 2017 to 36% TTM, and the company’s economic earnings more than doubled from $1.1 billion to $2.3 billion over the same period.

Figure 2: AutoZone’s ROIC: Fiscal 2017 – TTM

AutoZone Is Undervalued

At its current price of $2,197/share, AZO has a price-to-economic book value (PEBV) ratio of 0.9. This ratio means the market expects AutoZone’s NOPAT to permanently decline by 10%. This expectation seems overly pessimistic for a company that has grown NOPAT by 11% compounded annually over the past two decades.

If AutoZone’s NOPAT margin falls to 16% (equal to three-year average vs. 17% TTM) and the company grows NOPAT by just 3% compounded annually over the next 10 years, the stock is worth $2,867/share today – a 30% upside. See the math behind this reverse DCF scenario. Should the company grow NOPAT more in line with historical growth rates, the stock has even more upside.

Critical Details Found in Financial Filings by My Firm’s Robo-Analyst Technology

Below are specifics on the adjustments I make based on Robo-Analyst findings in AutoZone’s 10-Q’s and 10-K:

Income Statement: I made $461 million in adjustments, with a net effect of removing $281 million in non-operating expenses (2% of revenue).

Balance Sheet: I made $1.9 billion in adjustments to calculate invested capital with a net decrease of $206 million. One of the largest adjustments was $308 million (4% of reported net assets) in other comprehensive income.

Valuation: I made $11.0 billion in adjustments with a net effect of decreasing shareholder value by $11.0 billion. Apart from total debt, the most notable adjustment to shareholder value was $1.3 billion in outstanding employee stock options (ESO). This adjustment represents 3% of AutoZone’s market cap.

Disclosure: David Trainer, Kyle Guske II, and Matt Shuler receive no compensation to write about any specific stock, style, or theme.