My Brief View On EVs
To be frank, I've never been too keen on the EV market as an investor. The auto manufacturing industry, to begin with, is kind of ugly to me. Its razor-thin margins, intense competition, cyclical nature, and heavy CAPEX requirements have historically resulted in weak returns even from the rather high-quality players in the space.
Now, factor in the added risks associated with EVs-such as questionable adoption rates, reliability issues, and the increasing likelihood of Western manufacturers facing intense competition from their Chinese competitors in the coming decades-and you can see why I have avoided investing a single dollar in the space.
The point about adoption rates is actually the most important reason I can't convince myself to invest in EVs. Sure, EV sales are on the rise, but EVs as a percentage of all registered vehicles remain extremely low-in some states, the penetration rate is less than 1%.
While the above chart stops in 2022, the latest data available from the third quarter of 2023 also shows EVs as a percentage of all registered vehicles in the country have yet to exceed 1%.
I believe that investors are catching up to these concerns again in what may have previously appeared to be an exciting investment landscape. This is evident in the awful returns EV stocks, such as Tesla, Inc. (TSLA) or NIO Inc. (NIO), have recorded from 2021 to today and the notable underperformance versus the overall market during this period.
Opting For The Industry's Compounders
As I've outlined, generating sustainable and predictable returns from auto manufacturers, whether we are talking about ICE vehicles or EVs, proves challenging. Nonetheless, my attention has long been drawn to a distinct sub-sector within the industry: that of specialty retailers dealing in aftermarket parts, tools, supplies, and equipment.
I believe this space offers a sustainable route for investors to compound their capital while minimizing the risks attached to manufacturers. Clearly, the two leaders in the space, AutoZone, Inc. (AZO) and O'Reilly Automotive, Inc. (NASDAQ:ORLY) have produced market-beating returns for decades that resemble nothing of the performance of the underlying auto manufacturers.
Since I recently wrote an article on AutoZone explaining why I went big on that one, I want to pay more attention to O'Reilly Automotive on this one. I also think it's worth mentioning that I am not new to the stock. I published two bullish articles on it here on Seeking Alpha in January and March 2021.
Since they were published, the stock has returned 130.7% and 123.9%, outperforming the S&P500's total returns of 32.1% and 28.2%, respectively. Moving forward, I believe both are well-positioned to maintain this market-beating trajectory.
What Makes O'Reilly a Long-term Compounder
By taking a quick overview of O'Reilly's financials, it's easy to see why shares of O'Reilly have managed to compound at a market-beating rate over multiple decades.
The recipe for its success is simple:
- Continuously grow sales by opening new stores and maximizing same-store-sales,
- Continuously improve unit economics and unlock economies of scale to grow net income even faster,
- Allocate the entirety of free cash flow toward share buybacks, compounding the per-share net income growth even faster.
O'Reilly's track record in executing this strategy is absolutely phenomenal. In fact, since going public in 1993, O'Reilly has grown its sales to a new record every year. This is almost true for its net income as well, which, excluding a small decline in 2008, has also hit a new all-time high every single year over the same period!
Moving to my second point, with O'Reilly continuously maximizing same-store sales, it managed to achieve improving unit economics, leading to net income growth consistently outperforming revenue growth. As you can see, while its sales have grown at a CAGR of 9.05% over the past decade, which is an impressive pace on its own given how mature O'Reilly is at this point, net income has compounded at a much faster rate of 13.35% over the same period.
Finally, regarding repurchases and compounding of EPS, O'Reilly has bought back and retired about 58% of its shares since 2011. It might now come close to the legendary track record of AutoZone, which has retired about 90% of its shares since 1998, but still, it has allowed EPS to compound at an even faster pace than net income. To keep the same comparison time frame, O'Reilly's EPS has compounded at a CAGR of 20.34% over the past decade. I think it's fair to say this is a magnificent result, given the consistency of this success and how "boring" the underlying business model is at first glance.
Why I Keep Buying ORLY Stock Despite A Potential Valuation Risk
Over the past couple of years, I have been aggressively buying ORLY stock, and I intend to keep doing so despite the potential of a valuation-related risk. Let's take a deeper look!
As you can see, shares are currently trading at a forward P/E of 25.8, which implies a premium compared to the stock's historical average. This could be concerning, especially given that a valuation premium becomes increasingly hard to justify with interest rates at rather elevated levels.
However, I think this premium can be attributed to investors anticipating accelerating growth in the coming years. With auto parts for older vehicles becoming increasingly scarce and the average car age in the U.S. gradually moving higher, O'Reilly seems to be building strong pricing power, translating to accelerating growth.
According to S&P Global Mobility, the average age of light vehicles in the U.S. is growing rapidly, meaning demand for aftermarket parts is likely to remain elevated.
Thus, prices are on the rise. In 2022, for instance, the cost of parts sourced from automakers increased by 10%, while aftermarket parts prices rose by 17% - clearly outperforming inflation. This trend is likely to be sustained, thus favorably positioning O'Reilly for above-average growth in the coming years.
In any case, I feel very comfortable with growing my position at O'Reilly, even at a fair premium, as quality comes at a price, and the company has proven itself in that regard more than once.
In fact, given that uncertainty about investing in EVs is likely to persist given multiple unpredictable factors (the price of basic materials, geopolitical risk, and progress in EV infrastructure, amongst others), investing in O'Reilly, which has a proven model of compounding shareholder returns while also enjoying a natural organic growth tailwind (the rising average age of cars in the U.S.), seems like a choice with a far better risk/reward ratio, in my view.
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