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Fitch Rates AutoZone's $600MM Senior Unsecured Notes 'BBB'; Outlook Stable
April 6, 2017 / 4:56 PM / 8 months ago

Fitch Rates AutoZone's $600MM Senior Unsecured Notes 'BBB'; Outlook Stable

(The following statement was released by the rating agency) NEW YORK, April 06 (Fitch) Fitch Ratings has assigned a rating of 'BBB' to AutoZone, Inc.'s $600 million of new senior unsecured notes. Proceeds from the new issue will be used for general corporate purposes, including paying down commercial paper borrowings. A full list of ratings follows at the end of this release. KEY RATING DRIVERS The rating reflects AutoZone's leading position in the retail auto parts and accessories aftermarket, its consistent operating performance, and steady credit metrics. The ratings also consider the company's aggressive share repurchase posture with the company managing leverage around 2.7x over the last few years and using excess cash and debt to fund share repurchases. AutoZone is a leader in the large, growing and fragmented auto parts aftermarket. AutoZone competes in two markets. It is the number one player in its primary sub-sector, the $54 billion 'Do-It-Yourself' auto aftermarket (approximately 80% of AutoZone's sales) and a small but growing player in the $67 billion 'Do-It-For-Me' commercial auto aftermarket. Both the 'Do-It-Yourself' and 'Do-It-For-Me' segments have grown 2%-3% annually and are expected to continue growing at this rate. Approximately 85% of AutoZone's merchandise mix consists of either maintenance or replacement of failed products, for which demand is relatively stable. The company's sales have been resilient to both discount and online competition. Discounters have not invested in growing their auto parts sales due to the inventory breadth required to fully serve customers (across auto manufacturer, part, and model year) which results in low inventory turns. While online penetration has grown over time to around 5% of total industry sales, Fitch believes the bricks-and-mortar industry is somewhat protected due to the combination of high-touch service, purchase immediacy, low average ticket and restrictions on shipping for key items (i.e. batteries). In addition, AutoZone benefits from a still-fragmented industry, with the top five players in the combined retail/commercial space holding around 30% U.S. market share. Independent players, which continue to hold significant market share, have struggled as players such as AutoZone open stores with a larger inventory investment and ramp relationships with retail and commercial customers. This dynamic has permitted AutoZone to gain share over time without engaging in unhealthy price competition. As a result of the benign competitive environment, comparable store sales (comps) have averaged 2.5% over the past five fiscal years, including 2.3% in fiscal 2016 (ended August 2016). Comps have weakened modestly in recent quarters and were flat in the second quarter of fiscal 2017, due in part to weather conditions which limited miles driven and auto parts failures, and delayed tax refunds in early 2017. Going forward, Fitch expects AutoZone can sustain low single digit comps supported by 1%-2% comps on the retail side of the business and relatively faster growth in the commercial business. Overall sales growth should be in the mid-single digits due to the addition of around 200 units annually. AutoZone has among the strongest operating margins in the retail sector. The company's size, national footprint (it owns around half of its real estate), and retail-orientation have contributed to its industry leading EBITDA margin of 22.6% in the 12 months ending Feb. 11, 2017. Fitch expects EBITDA margins to remain in the 22%-23% range over the next few years, as fixed-cost leverage is mitigated by an increased mix of lower-margin commercial sales and rapid replenishment efforts to reduce out-of-stocks. AutoZone's credit metrics have been stable with adjusted debt/EBITDAR ratio (capitalizing operating leases on an 8x gross rent) at 2.7x over the past four years, reflecting an aggressive share buyback program. Fitch expects AutoZone will generate free cash flow (FCF) of around $900 million-$1.1 billion annually over the next three years. Excess FCF, together with some incremental borrowings, is expected to be directed towards share buybacks. Overall debt is expected to grow in line with EBITDAR, enabling the company to maintain its current leverage profile. KEY ASSUMPTIONS --Fitch expects AutoZone can sustain low single digit comps supported by 1%-2% comps on the retail side of the business and relatively faster growth in the commercial business. Overall sales growth should be in the mid-single digits due to the addition of around 200 units annually. --EBITDA margin should remain in the 22%-23% range, as fixed-cost leverage is mitigated by a gradually increasing mix of lower-margin commercial and online sales; --FCF of $900 million-$1.1 billion annually which will be directed towards share buybacks; --Debt levels are expected to grow in line with EBITDAR, enabling the company to maintain its current leverage profile. RATING SENSITIVITIES A positive rating action could be driven by stronger than expected operating results with a commitment by management to manage adjusted leverage in the low to mid 2x area. A negative rating action could be driven by softer operating results, including sales growth that trails the industry, a FCF margin below 8%-10% and/or an EBITDA margin below 20% for an extended period, or more aggressive share repurchase activity resulting in an increase in adjusted debt/EBITDAR to the low 3x area. LIQUIDITY AutoZone has adequate liquidity. The company maintains a $1.6 billion revolving credit facility (expiring November 2021 with an option to extend) and a $400 million 364-day facility, primarily to support commercial paper borrowings, letters of credit and other short-term unsecured bank loans. The available balance is reduced by commercial paper borrowings and certain letters of credit. As of Feb. 11, 2017, AutoZone had $174 million in available capacity due to $1.8 billion in commercial paper borrowings. Combined with cash of $211 million, total liquidity amounted to $385 million. FULL LIST OF RATING ACTIONS Fitch currently rates AutoZone, Inc. as follows: --Long-Term Issuer Default Rating (IDR) 'BBB'; --Senior unsecured debt 'BBB'; --Bank credit facility 'BBB'; --Short-Term IDR 'F2'; --Commercial Paper 'F2'. The Rating Outlook is Stable. Contact: Primary Analyst David Silverman, CFA Senior Director +1-212-908-0840 Fitch Ratings, Inc. 33 Whitehall St. New York, NY 10004 Secondary Analyst Monica Aggarwal, CFA Managing Director +1-212-908-0282 Committee Chairperson Steven Marks Managing Director +1-212-908-9161 Media Relations: Alyssa Castelli, New York, Tel: +1 (212) 908 0540, Email: alyssa.castelli@fitchratings.com. Date of Relevant Rating Committee: Aug. 4, 2016 Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor are disclosed below: --Historical and projected EBITDA is adjusted to add back non-cash stock based compensation and exclude restructuring charges. In fiscal 2016, Fitch added back $40 million in noncash stock based compensation to its EBITDA calculation. --Fitch has adjusted the historical and projected debt by adding 8x annual gross rent expense. 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