Analysis of AutoZone’s Financing Practices and Bond Choices

AutoZone’s Share Repurchase and Financing Practices

Task:

AutoZone (“AZO”) is a publicly traded company. There is plenty of information available, but for this exercise everything you need is within the following pages (see the Case Study). This situation takes place on February 1, 2012. We can easily research the share price for AutoZone and see that during the following year (02/01/12 – 02/01/13) the stock increased in value, but by a bit less that the S&P500 or other broad market indices. However, the period before 02/01/2012 and then again later in 2013 and onwards, the stock price performed well. We are also told in the case study that cash is returned to shareholders only through share repurchases (no dividends) and in fact, that is still the case today.

We are told that this individual, a “Mark Johnson” is concerned that Eddie Lambert’s reduced position in AZO could lead the company to reduce the intensity (size) of their share repurchases and change other aspects of its financing practices. You all know that Lambert sold his AutoZone stock to infuse capital in his hedge fund due to problems with his fund’s holding a Sears… a decision that by 2018 was proven to be horrific (since Sears went into the toilet and bankrupt). This case study and question has nothing to do with Sears – only the fact that a very major shareholder , and somebody considered “astute” was selling their AutoZone shares.

Comments (that may be of help):

All of the discussion about Lampert and Buybacks-versus-dividends, or whether cash flow will be used to pay-down debt involve questions about financing – how the firm distributes its cash to shareholders or arranges its sources of capital (balance sheet) between debt and equity.

We know that AutoZone does a great job in investing and operating efficiently. It has a very high return on invested capital (Exhibit 9), so they are clearly delivering Economic Value Added for their shareholders. The ROIC was something like 30% in the last year of the Case Study data.

We also know that there is a huge difference between Book Value (negative for AZO) and Market Value for their equity. This is not uncommon (Gartner/Google/Alphabet/Apple or even G.E. are examples of companies where Market Value is several times the value of Owner’s Equity (Book Value). Do not be fooled (or even concerned with this). In the case of AZO, the Book Value is negative since they have been buying back their stock. When this is done, the entry (simplistically) is:

Investment and Operating Prowess of AutoZone and Role in Financing

Debit: Owner’s Equity $1 (these debits can create negative values in the equity account - normally has a credit balance) Credit: Cash $1 (as is typical for anytime an asset account is reduced) So, in summary, since no dividends are paid on the stock, the cash is disbursed to shareholders by buying-back stock stock…. A lot of it, and that created the negative Owner’s Equity on the Balance Sheet. Since owner’s equity normally has a “credit” balance, a negative value means that it is a debit (negative value) for AZO on their balance (or a contra-credit which is basically the same thing).

All of you now know my belief that most of a firm’s economic value is basically created by its investing and operating prowess – how it creates Economic Value Added (or high Return on Invested Capital). In other words, by operating in a fashion that creates better returns than what it costs to chase those returns (earns more than the capital required times the cost of that capital). AZO is doing that. However, despite M&M’s theories that dividend payout versus share-buy-back is irrelevant, and also that debt/equity ratios are (in a simplified world) irrelevant, we know investors have preferences for what they want in the “real word” and that credit risk for debt can be an issue. Mark Johnson directly talks about his uncertainty on these topics if AZO changes its historical practices with Lampert now owning less of the stock.

Question 2

Remember: some of the information presented on the FINRA Bond Pages use numbers scaled to $100.  If the number looks “illogical”, but makes sense when multiplied or divided by 10, 100, or some other factor, then you know you are looking as a number scaled, for presentation, to a uniform “100”.  For example, the first bond is issued by the Federal Farm Credit Bank (CR BKS) - an agency of the U.S. Government.  The last price was $114.48 which obviously means $1,144.80 per $1,000.

Please see the six bonds in the 6-page PDF titled “Bond Choices.”  All come from FINRA which publishes data on every traded bond.  This is the data-source we used for all of the Bond examples we did earlier in the course.     All data is as of 11.11.2019 – and you answer the question as if that is the date of your analysis.  Please use only this data.  For each bond, you see the coupon rate, yield to maturity, date of maturity, and sorts of other information.    The lower portion shows you the amount of bonds issued.  For example, the Federal Farm Credit Bonds were part of a $23,000,000 issue (printed as 23,000 on FINRA) of which $17,150,000 are now outstanding.  Assume any bonds called (bought back) are bought back at par ($1,000 per $1,000 of face value, regardless of the market prices). 

The first two bonds both say “FEDERAL” so you can consider them to be U.S. Government bonds.  The next two are municipal (one State and one local), and the last two are Corporate Bonds.  All mature roughly the same time (10.5 – 11 years from now) and all traded in the last week. Most show credit ratings (helpful, but not perfect, since ratings agencies are often wrong). However, all are high-grade bonds.  Assume that the worst rated bond has a chance of default that is very, very low – let’s assume it is 1/2 of 1% for each of the first 5 years, and then a tad higher for the final years until maturity.  The other bonds with better credit ratings have odds of default even lower than that.

The Yield-to-maturity is referenced on the FINRA pages as the Last Trade Yield and as we did in class, includes the current coupon yield (coupon divided by current price) and also a “yield component” from the capital gain or loss on the Bond.  As covered in class, this capital gain or loss might arise since the current market price might be different than the final value of maturity (or sale price if it is called from you) when you are paid back the face amount (100 cents on the dollar, or whatever the call price is for that Bond).   One of the Bonds doesn’t show a Yield to Maturity… but if you buy that Bond you are certainly expecting to get paid something, somehow.