Michael A. Ball’s article, “The $318 Billion Market Amazon Could Easily Control“, is about the opportunities for Amazon (NASDAQ:AMZN) in the auto after-market industry. I do acknowledge the company has already entered this market and will grow its presence. But for 75-80% of this industry, there are barriers to entry related to allied services, which Amazon’s present model will not overcome. In addition, there are significant barriers to entry in this industry for a supplier without a large and geographically widespread bricks-and-mortar presence.
For the balance 25-30% of the industry, where Amazon will compete, the company has no particular competitive advantage apart from a willingness to cut margins and sell on price. Pricing at the margins leads to creation of marginal businesses, which Amazon already is, apart from the AWS business. The company might come to provide logistical support for parts delivery for a segment of the industry, but that will not provide the profit margins available from being the actual seller of the parts. Amazon is already in the business of selling parts, primarily to DIY retail and achieving sales growth. But its logistics capabilities do not provide any strong advantage in this particular industry, and any market share gains rely on a cut price approach.
The After-Market Auto Industry Market Amazon Can Most Easily Access
This Reuters Business News article, “U.S. auto parts sellers skid after report on Amazon’s entry”, states:
Shares of U.S. auto part retailers fell sharply on Monday following a report that Amazon.com Inc had set its sights on the $50 billion do-it-yourself after-market auto parts business.
Amazon is targeting a $50B market and not a $318B market. TABLE 1 below gives some idea of the current profitability of that market.
TABLE 1 summarizes the 2016 net income statements for 3 of the largest retailers of after-market auto supplies in the US (see SEC.gov 10-K reports for AutoZone Inc. (AZO), Advance Auto Parts Inc. (AAP), and O’Reilly Automotive Inc. (ORLY). The percentages applicable to retail come from the Reuters Business News report:
Northcoast Research analyst Nick Mitchell estimated that about 75 percent of Autozone’s sales come from the retail auto parts or the do-it-yourself market targeted by Amazon.The market accounts for low-50 percent of the sales mix for O’Reilly, low-40 percent for Advance Auto Parts and about 15 percent for Genuine Parts, Mitchell said.
Amazon Taking Market Share By Pricing Strategies
The total DIY retail sales of $16.198 billion, per TABLE 1 above, amounts to ~32% of the estimated $50 billion DIY retail sales referred to above. Let us assume Amazon takes ~32% of that existing market using pricing power. Reuters Business News describes the strategy:
Amazon has struck supply contracts with some of the largest parts makers including Federal-Mogul Holdings Corp (FDML), Dorman Products Inc, Robert Bosch GmbH and Cardone Industries Inc, NY Post reported on Sunday, citing sources. (nyp.st/2k8Ibhq)
The NY Post report implies that Amazon is both paying vendors more and offering customers lower prices than brick-and-mortar competitors on like-for-like products, according to RBC Capital Markets analyst Scot Ciccarelli.
TABLE 2 below shows how those approaches might affect the profitability of the assumed ~32% of DIY retail business I am projecting the company secures.
TABLE 2 above shows ~32% of existing DIY retail based on the three companies included in TABLE 1. It then shows a CASE A for Amazon based on securing ~32% of existing DIY retail sales by reducing existing selling prices by 10% and securing supply by paying 5% more for parts. While the existing retail business is quite profitable with good gross profit margins, CASE A shows reducing selling prices by 10% and increasing purchasing prices by 5% would be quite devastating for operating income (EBIT) margins and make the new business marginal.
CASE B assumes Amazon can substantially reduce Operating, Selling, and G&A expense (including fulfilment) to a total 27.8% of sales, in line with its existing businesses. This would allow the new business to operate profitably, although less profitably than for the 3 existing after-market auto companies.
Can Amazon reduce Operating, Selling, and G&A expense (including fulfilment) from the present 37.9% of sales for the existing 3 companies to 27.8% of sales, a 27% reduction?
The answer to the question in the heading is almost certainly “No!” Selling auto parts is for the most part very different to selling books. If I know I need a set of new spark plugs, there is possibly no urgency, and I could order them on Amazon and fit them after they arrive. But there are so many parts where I do not know exactly what I need without some expert advice and some diagnostic assistance. That can be provided on the web to some extent but nowhere as certain as consulting with experts at an auto parts store. When I determine what I need, I can purchase it then and there at the store. No matter how good Amazon Prime is, it will not be able to deliver auto parts across the length and breadth of the country in a one-hour time frame or anything like that. Amazon will not make large inroads into the after-market auto supplies business without a very extensive bricks-and-mortar presence, and with that will come the overheads of a bricks-and-mortar business. To understand why, read these excerpts from AutoZone’s 10-K for 2016:
AutoZone, Inc. (“AutoZone,” the “Company,” “we,” “our” or “us”) is the nation’s leading retailer and a leading distributor of automotive replacement parts and accessories in the United States. We began operations in 1979 and at August 27, 2016, operated 5,297 AutoZone stores in the United States, including Puerto Rico; 483 stores in Mexico; eight stores in Brazil; and 26 Interamerican Motor Corporation (“IMC”) branches. Each AutoZone store carries an extensive product line for cars, sport utility vehicles, vans and light trucks, including new and remanufactured automotive hard parts, maintenance items, accessories and non-automotive products. At August 27, 2016, in 4,390 of our domestic AutoZone stores we also had a commercial sales program that provides commercial credit and prompt delivery of parts and other products to local, regional and national repair garages, dealers, service stations and public sector accounts. We also have commercial programs in AutoZone stores in Mexico and Brazil. IMC branches carry an extensive line of original equipment quality import replacement parts. We also sell the ALLDATA brand automotive diagnostic and repair software through alldata.com and alldatadiy.com. Additionally, we sell automotive hard parts, maintenance items, accessories and non-automotive products through autozone.com, and accessories, performance and replacement parts through autoanything.com, and our commercial customers can make purchases through autozonepro.com and imcparts.net. We do not derive revenue from automotive repair or installation services.
We are dedicated to providing customers with superior service and trustworthy advice as well as quality automotive parts and products at a great value in conveniently located, well-designed stores. Key elements of this strategy are:
Customer service is the most important element in our marketing and merchandising strategy, which is based upon consumer marketing research. We emphasize that our AutoZoners (employees) should always put customers first by providing prompt, courteous service and trustworthy advice. Our electronic parts catalog assists in the selection of parts as well as identifying any associated warranties that are offered by us or our vendors. We sell automotive hard parts, maintenance items, accessories and non-automotive parts through autozone.com for pick-up in store or to be shipped directly to a customer’s home or business. Additionally, we offer smartphone apps that provide customers with store locations, driving directions, operating hours, ability to purchase products and product availability.
Our stores generally open at 7:30 or 8 a.m. and close between 8 and 10 p.m. Monday through Saturday and typically open at 9 a.m. and close between 6 and 9 p.m. on Sunday. However, some stores are open 24 hours, and some have extended hours of 6 or 7 a.m. until midnight seven days a week.
We also provide specialty tools through our Loan-A-Tool program. Customers can borrow a specialty tool, such as a steering wheel puller, for which a do-it-yourself (“DIY”) customer or a repair shop would have little or no use other than for a single job. AutoZoners also provide other free services, including check engine light readings where allowed by law, battery charging, the collection of used oil for recycling and the testing of starters, alternators and batteries.
And from William C. Rhodes, III Chairman, president and CEO, AutoZone, Inc., on the Q2 2017 earnings call:
Yeah. I don’t think there’s any question that they’re [Amazon] priced below us in many different cases, but I think the value proposition is extraordinarily different. Number one, the convenience factor, you can walk into our store and the sense of immediacy, particularly if you have a failure part that’s right at your hand, so you can get back on the road immediately versus having to wait overnight or a couple of days in most cases. I don’t think many consumers today are willing to wait when their car is down for that. So, that’s one element. There are many elements.
Another element is we’ve got tremendous trustworthy advice in our AutoZoners in-store. That comes with a cost and, therefore, it’s part of the value proposition. But for an AutoZoner to help a customer figure out what is going on with their vehicle and what the solution is, there’s value to the customer in that. We do core returns – a significant amount of our sales come with a core return where they’re to take that core back and on and on and on.
So, I think we feel like there’s a significant value proposition differential between us and any online competitor. And what happens with that over time, we’ll see. We’ve dealt with price competition for years. And some of that price competition, for instance, is in mass merchandising, and we’ve effectively managed through that over the years because there’s a different value proposition. So, we don’t see it necessarily any different.
On an earnings call, Paul D. Donahue, the CEO of Genuine Parts Company (GPC), was questioned about Amazon, and he replied:
Again from the Reuters Business News report referred to above:
Ciccarelli said Amazon’s reach will be relatively limited in scope as most retail customers likely don’t have the information and skill sets needed to comfortably order parts on their own.
That is only the DIY retail side of the business. As Paul Donahue explains above, “… 75% to 80% of our total NAPA business. It’s difficult for Amazon…” He explains that for this 75-80% of business, required delivery times of 30 minutes are tough and only achievable with its 6,000 stores and 60 distribution centers. Amazon cannot match that.
Summary And Conclusions
The after-market auto parts business is sizeable at $318 billion. But there are high barriers to entry for a significant part of this business. Amazon has already made inroads into the segment of the market where the barriers to entry are lower, and its logistics capabilities are an advantage, mainly by cutting prices. It will also likely be able to grow business in the segments where a bricks-and-mortar presence is required by offering logistical services to these existing businesses, but that is also low margin business for Amazon.
TABLE 2, CASE B above gives an indication as to the level of EBIT ($2.06B) Amazon might generate from ~32% of the $50 billion DIY retail auto parts business. If I apply the average Price/EBIT ratio of 10.56 for the 3 existing businesses (per TABLE 1) above to the EBIT of $2.06B, I arrive at a potential valuation for this new and emerging business of ~$22B, and that could be a fair valuation.
If I multiply the $2.06B by Amazon’s current Price/EBIT ratio of ~110, I arrive at a $227B valuation, and that certainly is not a fair valuation. It would need ten businesses fairly valued at $22B to come close to that $227B valuation. $227B is less than half of Amazon’s current market cap of $467B. And based on the comments above, it will likely take years for Amazon to grow these many businesses that so many investors can imagine. If the rate of share price growth drastically slackened to 10% per year, the market cap would still increase by another $46B per year, requiring another two $22B value new businesses per year to be added on, in addition to the ten referred to above, to justify the market cap.
The Amazon business is an outstanding business, but even for that, the share price has finite limits. Based on the figures, it would seem these finite levels have been exceeded by a long way and the share price is limited only by the imagination of buyers. If it were not for the strong sentiment for this stock, which may continue to cause the share price to grow, I would say Amazon is a sell or a short. I certainly would not consider it a buy at current share price levels. While shorting may be an option, anyone doing that would need to fully understand the risks involved, which is beyond the scope of this article
I have a different view on that other FANG stock, Apple Inc. (AAPL), and will be authoring an article to give my take on why Warren Buffett is attracted to this stock for investment by Berkshire Hathaway (BRK.B). If you want to be sure to catch that article, please press the “Follow” button.
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