O’Reilly Automotive Stock: Looking At Mexico And Canada For Future Growth (NASDAQ:ORLY)

O’Reilly Automotive, Inc. (NASDAQ:ORLY) provides aftermarket parts for consumer cars, including products such as alternators, batteries, engine parts, and fuel pumps. In addition, the company offers services. The company predominantly operates in the United States but has a small and growing number of stores in Mexico, too. At the end of 2023, the company had 6095 stores in the United States and an additional 62 in Mexico.

With O’Reilly’s impressive organic and quite capital-light growth, the stock has been a very great long-term compounder. In the past thirty years, the stock has had an astounding CAGR of 20.7%. O’Reilly chooses to spend its capital for organic growth and share buybacks, so the company doesn’t pay out a dividend.

An Excellent Financial Track Record

O’Reilly’s financial track record is very impressive. The company has grown its revenues from $1512 million in 2003 into $15812 million in 2023, representing a CAGR of 12.5% in the past two decades with minimal acquisitions. The company has been able to expand its store footprint with internal financing, even managing to decrease the total outstanding shares in the period significantly with leftover cash flows; O’Reilly’s current return on total capital of around 34.4% has made the company’s growth very light in capital.

With the growing store count, O’Reilly has also achieved significant operating leverage resulting in a currently very healthy trailing operating margin of 20.2%. I believe that the margin could still have some room upwards in the mid- to long-term – as O’Reilly’s operations in Mexico become more established making the cost profile likely more effective, and as overall revenues look to continue to grow in coming years with a gross margin in the low fifties, the margin should still have some room for expansion.

Mexico & Canada Provide a Future Growth Runway

To continue the stock’s compounding, O’Reilly needs to keep up a good pace in growth. The store count growth in the United States has slowed down beginning in 2020, though – net new stores have gone down from an average of 199 from 2013 to 2019 into an average of 164 from 2020 to 2023.

O’Reilly guides for net new store openings of 190 to 200 in 2024. The figure is up slightly from the achieved 186 total in 2023 – the growing store count does still prove a good amount of room to grow in the United States as O’Reilly continues to capture market share. The industry does have other prominent players, though, potentially limiting the long-term continuation of large market share capture – for example, AutoZone has a story quite similar to O’Reilly’s, and while Advance Auto Parts’ financials lag the two prior’s trajectory, it also plays a key role in the market.

With the slower store count growth in the United States, the company’s expansion into Mexico plays a key part in future growth in my opinion. The company expanded into Mexico in 2019 with the acquisition of Mayasa Auto Parts, and has since also started to expand with the O’Reilly brand. Although the store count is still insignificant in the large picture, the store footprint is rapidly growing – in 2023, total stores in Mexico grew by 20 into 62. An exponential growth in Mexican stores could make for good continuation in O’Reilly’s long-term growth story. In July of 2023, O’Reilly announced a new distribution center in Mexico, in my opinion proving the company’s ambition for a greater store network in the country as O’Reilly’s Chip Carlson communicates in the press release.

In December of 2023, O’Reilly announced a definitive stock purchase agreement with Groupe Del Vasto. The acquired company operates 23 company-owned stores in Canada under the Vast-Auto Distribution name. The acquisition is quite small, but could provide a pathway to greater operations in Canada as the acquisition of Mayasa Auto Parts seems to have done in Mexico. I find the growth initiatives in Mexico and Canada as potentially great initiatives, and a critical component in O’Reilly’s long-term growth.

Valuation Leaves Little Short-Term Upside

Understandably with O’Reilly’s fantastic track record, the stock trades at quite a high forward P/E. Currently, the multiple stands at 24.9, above the stock’s 15-year average of 20.4.

As usual, I constructed a discounted cash flow model to estimate a fair value for the stock. In the DCF model, I estimate O’Reilly’s growth to continue with a 2024 revenue growth of 7.5% in line with the company’s guidance. Afterwards, I estimate slightly higher growth at 8% for 2025 and 2026, and a gradual slowdown into a perpetual growth rate of 3%. I believe that the described revenues factor in O’Reilly’s growth opportunities in Mexico and Canada as well as domestic opportunities fairly. The total estimated CAGR from 2023 to 2033 is 6.3%. As priorly explained, I believe some margin expansion in the long term is in my opinion a fair assumption. I estimate the company’s EBIT margin to rise from 20.0% in 2024 into an eventual stable level of 22.5%. The company’s capital-light strategy leaves the company with healthy cash flows despite investments, and consistent net working capital decreases have further supported quite a great cash flow conversion in the long term, which I estimate to continue going forward.

With the mentioned estimates along with a cost of capital of 7.91%, the DCF model estimates O’Reilly’s fair value at $1096.89, around 4% above the stock price at the time of writing. As such, I don’t really see great short-term upside for stock appreciation. Still, the stock could prove to be a fantastic long-term pick if the capital-light growth is continued.

The used weighed average cost of capital is drawn from a capital asset pricing model:

In Q4, O’Reilly had $56.1 million in interest expenses. With the company’s current amount of interest-bearing debt, O’Reilly’s annualized interest rate comes up to quite a low 4.03%. The company leverages debt quite modestly, and I estimate a long-term debt-to-equity ratio of 10%.

For the risk-free rate on the cost of equity side, I use the United States’ 10-year bond yield of 4.34%. The equity risk premium of 4.60% is Professor Aswath Damodaran’s latest estimate for the United States, made on the 5^th of January. Yahoo Finance estimates O’Reilly’s beta at a figure of 0.86. Finally, I add a very small liquidity premium of 0.1%, crafting a cost of equity of 8.40% and a WACC of 7.91%.

Final Thoughts & Takeaway

O’Reilly has undisputably been a fantastic growth story in terms of value creation, as the company’s capital-light growth has left room for great stock buybacks on top of great organic earnings growth. While the growth of new stores has slowed down considerably in the United States in recent years, O’Reilly has found new avenues for long-term growth in Mexico, and most recently, Canada – I believe that the company still has a good growth runway ahead. As my DCF model doesn’t estimate the stock to be undervalued, and doesn’t really leave room for sustainable short-term appreciation in my opinion, I have a hold rating for the stock. Still, I recognize the great long-term story, and the Mexican and Canadian markets’ potential for a valuable continuation in the story & stock appreciation.