🗞 The Retailer Even Amazon Couldn't Kill

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This week, we’re taking a look under the hood (pun intended) at the world’s largest auto parts retailer, O’Reilly Automotive.

This seemingly simple concept is now more than a 550-bagger for investors since its 1993 IPO.

Let’s dive in!

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O’Reilly Automotive: The Last Mile Moat

A Family Operation

In 1957, in Springfield, Missouri, the very first O’Reilly Automotive store opened its doors to the public.

Prior to the opening, Charles F. O’Reilly and his son Charles H. (Chub) O’Reilly were both working for another parts supplier in the area called Link Motor Supply. However, after Link was bought out, they announced a corporate restructuring that would have forced Charles into retirement and Chub out of state. So the father and son duo decided to break away and launch their own store with cash they’d saved up over the years.

Introducing O’Reilly Automotive.

While most people recognize O’Reilly today as the store that anybody can walk into to get the auto parts they need, serving individuals wasn’t the focus in the early days.

Charles, Chub, and the 12 former colleagues that left Link and joined them, had deep connections with mechanics across the Springfield area. That’s the customer base that O’Reilly decided to focus on serving, and it was an instant success. In the first month, O’Reilly generated $27,000 in sales, and by the end of the first year, they had brought in $700,000.

O’Reilly was officially in business.

Beyond the Midwest

Soon enough, O’Reilly was generating so much business from local mechanics that they decided to start expanding their footprint throughout Missouri. In 1960, O’Reilly established a distribution center called Ozark Automotive Distributors. This distribution center would go on to serve as the foundation for O’Reilly’s massive multinational supply chain that powers the business today.

Towards the late 1960s, O’Reilly began to realize that demand for auto parts extended beyond just mechanics. Typical car owners needed parts too and would often come to O’Reilly stores looking for products. In response, O’Reilly launched a dual market strategy that still exists today. Their retail centers serve as storefronts for “Do-It-Yourself” (DIY) customers, while they deliver parts to professional mechanics from both their distribution centers and “hub stores”. Both of these customer types account for roughly equal split of the business today.

By the 1990s, O’Reilly had become one of the leading auto parts retailers in the midwest. The company had more than 100 stores located in Missouri and other surrounding states, but it was still a long ways from becoming the international giant that it is today. If they were going to expand, they needed capital.

So on April 23rd, 1993, O’Reilly Auto Parts went public. This gave the O’Reilly family the funding they needed to supercharge growth.

O’Reilly knew that if they were going to expand outside of their existing service regions, the most effective way to do so would be by purchasing existing stores instead of building them from scratch. This acquisition strategy was more effective for a few reasons:

• The Dual-Market Revenue Lift: Unlike O’Reilly, most auto parts chains focus on a single customer type, either professionals or individuals. Once O’Reilly acquires a competitor, they can retrofit their distribution centers to better serve professionals. That means more SKU availability, more frequent deliveries, etc.

• Instant Market Density: When you acquire the dominant chain in a specific region, you don’t have to deal with the inefficiencies that come with building a network one-by-one. You already have the brand, the local customer base, and the route density for more economical shipment deliveries.

• Eliminates Local Competition: Instead of fighting a market share battle one store at a time (and potentially having to compete on price), O’Reilly can instantly become the preferred provider in a region.

• Better Real Estate: In mature markets, the prime real estate is usually already occupied. By acquiring a competitor, O’Reilly can automatically take over the best locations with the most potential traffic.

O’Reilly first started putting this expansion strategy to work in 1998 with their acquisition of Hi/LO Auto Supply based out of Texas. Hi/LO added 182 new stores and a distribution center, effectively doubling O’Reilly’s footprint and placing them in the top 10 auto parts chains in the US.

They followed this acquisition with several smaller roll-ups throughout the early 2000s, with each one adding 50-100 new stores and expanding them into a few new states. It wasn’t until 2008 that they took this strategy to the next level. On July 11th, 2008, O’Reilly finalized their acquisition of CSK Auto Corporation for $1 billion in cash and stock. CSK added 1,342 new stores to the O’Reilly network and gave them a massive foothold in the Western US, particularly California. This vaulted O’Reilly into being the 3rd largest auto retailer behind AutoZone and Advanced Auto Parts.

An Enduring Market

Part of what has made O’Reilly such a massive success story is simply that they were in the right industry at the right time. Following World War 2, there was a massive automotive boom in the United States.

Cars were becoming more affordable thanks to heavy investments in production capacity. Suburbanization was on the rise making car ownership more of a necessity than a luxury. And the Interstate Highway Act was signed in 1956, which funded the construction of the U.S. Interstate Highway System we now know.

Today, there are roughly 297.5 million registered vehicles in the United States, compared to just 56 million when O’Reilly was founded. That’s a figure that continues to grow by 1%-2% with each passing year.

On top of the sheer vehicle volume growth, the average age of vehicles on the road has continued to rise as well. As cars get older, the more things go wrong, the more often they need to be serviced. For O’Reilly, that means more demand.

These enduring tailwinds have benefitted the entire auto parts industry, O’Reilly included.

The “First Call” For Mechanics

O’Reilly got its start by serving professionals, and that’s still the market they dominate today. While AutoZone and other competitors have a large presence with individual customers, O’Reilly generates more revenue for professional service providers than any other company in the industry.

If a mechanic needs to order new brake pads for a customer, O’Reilly would be their first call. In fact, they’d probably just order the parts directly from O’Reilly’s parts supply website firstcallonline.com. Within a few hours, an O’Reilly delivery vehicle would show up with the required parts.

O’Reilly has 32 distribution centers, 399 hub stores, and a massive company-owned delivery fleet that provides their stores and professional service customers same-day access to 63,000 different SKUs. This is truly a massive differentiator for O’Reilly since they are able to provide multiple same-day deliveries to more than 95% of their own stores. This gives end-customers timely access to the widest range of products in the industry.

This hub-and-spoke distribution network is the foundation behind O’Reilly’s moat.

E-Commerce Proof

On July 5th, 2017, shares of O’Reilly Automotive suffered a massive single-day drop of 20%.

This culminated in O’Reilly reaching a more than 40% drawdown from previous highs.

The culprit? Mild winter weather.

Leading up to O’Reilly’s Q2 report, there was growing fear on Wall Street that Amazon was going to decimate traditional brick-and-mortar auto retailers since the e-commerce giant had signed direct supply agreements earlier that year with several major auto parts manufacturers.

This narrative had investors on edge. So, in July 2017, when O’Reilly reported 1.5% comp store sales versus the company’s expectations of 3%-5%, the stock sold off hard.

Despite the underwhelming results being simply attributable to milder weather than management expected, to skeptics, it was proof that the Amazon narrative was coming to fruition.

Fast forward 9 years and the average O’Reilly store now generates roughly $2.7 million in annual revenue, up 51% compared to 2017.

Around this time, famous investor Chuck Akre wrote a letter that said:

“During the second quarter and more so in the third, we purchased more than 1 million shares of O'Reilly, tripling the number of shares owned in what we consider a truly world-class retailer. While we never say never, especially when it comes to Amazon, we believe that auto parts generally, and O'Reilly in particular, are relatively insulated from material online disruption.”

So how come Amazon never had the impact Wall Street feared? As it turns out, more than 80% of orders are for either critical or maintenance parts. That means they don’t have time to wait.

Whether it’s a DIY customer that needs to get back on the road or a mechanic that needs an urgent part, most customer visits are highly specific and time sensitive.

Thanks for reading! That’s all for this week. 

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