BB&T Capital Markets today released its most recent note on O’Reilly Auto Parts, focusing on the company’s recent and ongoing conversions of former CSK stores in the Midwest over to the O’Reilly format.
In the note, BB&T discusses the conversions and the differences that may result in less revenue drag than that seen with the initial Midwest CSK store conversions. BB&T also highlights the progress to date, what’s left to do and how it might impact sales trends for the next couple of years, as well as provide more detail with respect to underlying assumptions for new 2011 estimates. Below are highlights from the note.
Maybe the term “conversions” is a bit misleading We would almost categorize the initial rebranding process of the Midwest CSK stores to O’Reilly stores as a “transformation” rather than simply a conversion. Conversely, as we show in this report, for the West Coast locations, store-level teams will not have to adapt to myriad changes all at once. Instead, the process will be gradual with roughly 30 stores per distribution center being converted each week.
Quicker timeline on the West Coast In the Midwest, stores were required to close for roughly one week due to the sheer amount of work involved to completely reset the stores; CSK stores on the West Coast will be switched overnight (simply swapping the POS terminals and servers), allowing for the stores to open for normal business the following morning. Because the stores on the West Coast will reopen the following day, we anticipate a much less disruptive impact to sales trends.
Pace of conversions impressive, particularly given the size of the CSK acquisition (1,300 stores, relative to 182 for Hi/LO, 82 with Midstate, and 72 with Midwest). At the end of the third quarter, 264 CSK stores had been converted, or 20 percent of the CSK store base. The West Coast conversions are well underway with both the Seattle and Southern California DCs online and fully operational, and we expect 57 percent of the CSK stores to be converted by the end of the first quarter of 2010.
But some volatility likely in the first half of 2010. With almost 500 stores likely to be converted in the fourth quarter of 2009 and the first quarter of 2010, we believe that risk related to a potential conversion mishap is likely to weigh on the shares for much of the first half of 2010. That said, in the absence of any integration difficulties, we expect a diminishing risk profile with each coming quarter to serve as a catalyst to multiple expansion as investors begin to shift focus to the significant growth potential that exists in 2011 and beyond.
Maintaining our 2010 EPS estimate of $2.62 While we believe that our current +4.1 percent SSS estimate could prove conservative (with potential upside from greater-than-anticipated performance at CSK), we would caution investors not to set 2010 expectations too high given the expense required to open four new distribution centers, train employees and convert 850 stores. There remains significant work to do.
…but 2011 could be a big year for O’Reilly as duplicate costs are removed and store productivity accelerates; we are initiating a 2011 EPS estimate of $3.20 (+22 percent yr/yr). With an improved parts mix and complete inventory replenishment capabilities at CSK, we believe that O’Reilly will be very successful in both (1) maintaining and expanding DIY, albeit slowly, and (2) layering in additional wholesale business. With CSK generating less than $200,000 in commercial sales per store, we see above-trend (+20 percent) DIFM growth annually for multiple years as the gap is closed relative to wholesale productivity at O’Reilly ($725,000 per store).