O’Reilly Automotive (ORLY) — one of the largest U.S. retailers of automotive aftermarket parts and accessories — carries our highest investment recommendation of 5-STARS, or Strong Buy, asserts equity analyst Garrett Nelson in CFRA Research's  flagship newsletter, The Outlook.

O’Reilly Automotive is one of the largest U.S. retailers of automotive aftermarket parts and accessories, with 5,971 stores in 47 states (5,929) and Mexico (42) as of December 31, 2022.

ORLY has a dual market strategy, targeting Do-It- Yourself (DIY) customers as well as Do-It-For-Me (DIFM) customers (auto repair shops). In FY 2022, 56% of the company’s sales were to the DIY market and 44% were to DIFM customers.

Our favorable investment view reflects positive auto aftermarket fundamentals being driven by a record-high average U.S. vehicle age (12.5 years as of 2023), an opinion that ORLY is a high-quality name (about 51% gross margins) with a history of returning capital to shareholders via share repurchases, and a stock which has historically performed well during periods of slower economic growth.

We think ORLY’s growth will be supported by solid comp sales growth of roughly 7.5% and 185 net new store openings in 2023, as well as market share gains at the expense of certain auto aftermarket competitors. ORLY has a long history of profitable and aggressive greenfield growth, adding new stores to grow market share across its existing footprint and expanding into new markets. The company has opened at least 155 net new stores each year since 2011.

We note the company’s strong recent earnings track record (only two bottom-line misses in the past 15 quarters) and long history of providing conservative guidance. Our EPS estimates of $38.20 for 2023, $43.45 for 2024, and $46.85 for 2025 imply solid growth from the $33.49 it earned in 2022.

On October 25, ORLY posted Q3 EPS of $10.72 versus $9.17 (+17%), well ahead of the $10.42 consensus. The beat was driven by a stronger-than-anticipated top line, as revenue increased 11% to $4.20 billion ($120 million ahead of consensus) on an 8.7% increase in comp store sales (consensus was 5.8%).

Gross margin expanded 50 bps to 51.4% (30 bps ahead of consensus). ORLY also raised prior 2023 EPS guidance to $37.80-$38.30 from $37.05-$37.55. Following the earnings release, we raised our opinion to Strong Buy from Buy.

One of the key factors that has and should continue driving strong EPS growth is ORLY’s aggressive share repurchase program. Since ORLY began its share repurchase program in 2011, it has bought back roughly 60% of its total share count, or approximately 93.9 million shares, at an aggregate cost of $23.04 billion.

In 2023, we estimate ORLY’s gross margin will decline by 10 bps from the 51.2% margin posted in 2022, as inflationary pressures and supply chain issues pressure margins. Higher net sales should help with fixed cost absorption.

The basis of our 12-month target price of $1,100 is 23.5x our 2025 EPS estimate, a slight but justified premium to the stock’s 10-year average forward P/E of 22.4x.

Risks to our recommendation and price target include a decrease in the average vehicle age and new car sales, a reduction in miles driven, and greater competition from online sellers. We also see risks related to less vehicular maintenance from the long-term growth of electric vehicles (EVs) and a contraction in the valuation shareholders are willing to pay for ORLY’s rapid growth.

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