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. ___________________________________________________________________
The Question: Based upon the enclosed information in the case study, and strictly because he has heard that Lampert is selling, what should Johnson do with his AutoZone Investment on 02/01/2012?? Why? ___________________________________________________________________Note: I expect you to address why this is not so “clear cut” a decision…. the reasons why, or why not having Lampert exit could have a material impact on the business practices and valuation of AZO – and then weigh these factors to give me your decision… and why.
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:
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.
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