Case in Point: AutoZone keeps focus on share repurchases instead of switching to dividends


Instead of switching to paying dividends, AutoZone kept with share repurchases. (Daniel Acker/Bloomberg)
June 20

The big idea: A company’s CFO faces financial policy decisions related to how funds are invested in the business or distributed to shareholders. In 2012, equity analysts were watching AutoZone to see if the company would change its longtime use of share repurchases as a means of distributing cash to its shareholders. Would it switch from a share-repurchase strategy to paying dividends? Or would it use the cash to add retail stores to further bolster growth?

The scenario: AutoZone, an aftermarket auto-parts retailer had seen strong stock price appreciation since 1997, with an average annual return of 11.5 percent. While other companies limped through the 2008 recession, it had strong top-line and bottom-line growth — people were fixing their cars to postpone buying a new one.

From the beginning, AutoZone had invested heavily in expanding its retail footprint via organic and inorganic growth, which led to strong revenue growth. It also developed a sophisticated hub-and-feeder inventory system that kept inventories of individual stores low while minimizing the likelihood of stock outs. It boasted both the highest operating margin in its industry and strong customer service.

AutoZone’s management focused on return on invested capital (ROIC) as the primary measure of value creation. As a result, while it invested in opportunities that led to top-line revenue growth and increased margins, it also focused on capital stewardship.

Starting in 1998, AutoZone had returned capital to shareholders through share repurchases. AutoZone’s consistent repurchases reduced the number of shares outstanding by 39 percent from 2007 to 2011. The repurchases had been funded by operating cash flows and debt issuances. A share repurchase also had the effect of reducing a company’s equity on the balance sheet. Because AutoZone had been increasing its debt outstanding as it was decreasing the equity outstanding, its invested capital had remained fairly constant since 2007, which, when combined with rising earnings, resulted in strong measures of ROIC.

Investors speculated that the driving force behind AutoZone’s strategy was a large hedge fund investor, Edward Lampert. The repurchases started around the time Lampert acquired a stake in AutoZone and accelerated as he built his position. Several years later, AutoZone’s Lampert began to rapidly liquidate his stake. What sort of signal would this be to the market? If AutoZone discontinued its share-repurchase strategy, would the stock price suffer after so many years of outperforming the market?

The resolution: A key element behind equity analysts’ reaction to such a change is the logic of the change and whether it was consistent with creating value for the enterprise. Would Lampert’s move be interpreted negatively? Would AutoZone change its stock repurchase strategy with his exit?

Analysts did not interpret Lampert’s liquidation of AutoZone as a negative signal, because they could see the motivation was his need for funds within his hedge fund. AutoZone continued its long-held strategy of repurchasing shares. Its stock kept appreciating along with the overall stock market.

The lesson: The question for AutoZone was how to best distribute its cash flows. The decision to continue repurchasing shares had neither a strong positive or negative impact on its share price. But if investing in new stores rather than repurchasing shares would have increased ROIC, then stock price should have been more favorably affected by pursuing a higher organic growth strategy.

— Kenneth Eades, Justin Brenner and Gerry Yemen

Eades is a business professor and Yemen is a senior researcher at the University of Virginia Darden School of Business. Brenner is a graduate of the Darden School.

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