The difference in store footprints is not the only distinction between O'Reilly and CSK, as the two companies also have a very different mix of retail and commercial business, which in turn requires unique distribution networks. Given CSK's higher DIY exposure (82 percent), the company's distribution network consists of a fewer number of larger distribution centers (DCs) to deliver larger store inventory replenishments, but on a less frequent basis. O'Reilly, on the other hand, has been serving the professional repair market since 1957, and its extensive network of DCs and hub stores allow it to make daily deliveries to its store base. O'Reilly has the most distribution-intensive model of the dual marketers, with (1) the greatest amount of DC space, (2) the highest number of distribution employees per store, (3) DC square footage per unit of retail space that is twice that of its peers and (4) the highest allocation of DC space per store.
So what should we expect in the coming months? At this point, three phases to the initial integration process have been outlined.
The first phase focuses on the conversion of 160 Checker stores in the Southwest, implementing new IT and point-of-sale (POS) systems, once-a-day-store replenishment capabilities, inventory investment at the store level and switching of the exterior signage. Phase 1 is under way and expected to be finished in mid-February 2009.The second phase will consist of making the same inventory investments, store level hires and IT synchronization of Phase 1, this time at 60 Murray's stores in the greater Chicago area. Phase 2 also will involve process and systems improvements at CSK's Belleville, Mich., distribution center. Phase 2 will be finished by mid-March 2009.
The third phase of the initial integration process will be West Coast focused, with comprehensive product line and customer evaluations, in addition to developing a significant West Coast distribution network. O'Reilly management appreciates the strength of the Checker, Schuck, and Kragen brand profiles on the West Coast (particularly with the DIY consumer) and will take its time in making the final conversion over to O'Reilly signage.
We think that one of the first priorities for O'Reilly will be to maximize the productivity of CSK's existing stores through a combination of inventory investment, parts availability initiatives and enhanced customer service. A large part of this process will be the implementation of O'Reilly's culture and dual-market operating model. We expect O'Reilly to add three to four DCs on the West Coast over the next 12 to 18 months, and O'Reilly development teams are actively evaluating potential sites. While many CSK store planograms will need to be modified, the store base is in decent condition, leaving the real work to be done behind the counter.CSK has significantly underperformed its peers on most metrics. In spite of CSK's heavy West Coast presence, the company trails Advance, AutoZone and O'Reilly in revenue per store. We think the below–peer group sales productivity is caused by two primary factors: low inventory per store and below-average customer service, as measured by retail associates per store.
CSK carries $372,000 in inventory per store, roughly 23 percent less than its peers. While CSK's inventory turn of two times per the last fiscal year (LFY) may appear stronger at first glance, we think it is indicative of the company not carrying enough product in stock. We would note that CSK's inventory includes items that are non-automotive in nature and could be replaced with higher-demand core automotive hard parts and chemicals. Additionally, CSK averages 9.4 retail associates per store, far less than Advance and AutoZone. On the retail side, CSK generated $1.13 million LFY in DIY sales per store, well below AutoZone at $1.3 million, but above Advance at $1.1 million and O'Reilly at $0.756 million. In our opinion, this level should be higher given the favorable delta on operating in the West Coast market. On the commercial side, CSK's do-it-for-me (DIFM) sales per commercial program of $470,000 exceeds AutoZone at $327,000, but trails Advance at $493,000 and O'Reilly at $735,000.
We suspect that the initial forecast of $100 million in annual cost savings will prove conservative, and although not included in our estimates, we see areas for at least $25 million in potential savings. There is a great deal of work to be done; merging the two companies will not be accomplished overnight.
BB&T Capital Markets is a full-service investment-banking firm that focuses on specific industries, including the automotive aftermarket industry. BB&T Capital Markets is a division of Scott & Stringfellow, Inc., NYSE/SIPC. Scott & Stringfellow is a registered broker/dealer subsidiary of BB&T Corporation, one of the nation's largest financial holding companies with $136.4 billion in assets.
Disclosures: BB&T Capital Markets makes a market in the securities of Dorman Products, Inc.; Monro Muffler Brake, Inc.; Motorcar Parts of America, Inc.; and O'Reilly Automotive Inc.
BB&T Capital Markets expects to receive or intends to seek compensation for investment banking services from Advance Auto Parts, Inc.; AutoZone Inc.; Dorman Products, Inc.; Genuine Parts Company; Midas, Inc.; Monro Muffler Brake, Inc.; Motorcar Parts of America, Inc.; O'Reilly Automotive Inc.; Standard Motor Products, Inc.; and The Pep Boys—Manny, Moe & Jack in the next three months.
Advance Auto Parts, Inc.; Midas, Inc.; and Monroe Muffler Brake, Inc. are, or during the past 12 months were, clients of BB&T Capital Markets, which provided non investment banking, securities-related services to, and received compensation from, the aforementioned companies for such services. The analyst or employees of BB&T Capital Markets with the ability to influence the substance of this report knows the foregoing facts.
An affiliate of BB&T Capital Markets received compensation from Advance Auto Parts, Inc.; AutoZone, Inc.; Genuine Parts Company; Midas, Inc.; Monro Muffler Brake, Inc.; and O'Reilly Automotive Inc. for products or services other than investment banking services during the past 12 months. The analyst or employees of BB&T Capital Markets with the ability to influence the substance of this report know or have reason to know the foregoing facts.