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Feb 7, 2017

S3 BLACKLIGHT: Shorts Turbocharged as Autozone gets Amazon-ed

Autozone Inc. (AZO US) short sellers had a dismal 2016, paying $6.4 million in financing costs on their $1.91 billion average short position, which was down $126.0 million, or -6.59% for the year. As a result of these losses, short interest had been declining since Autozone short interest hit its historical high of $2.06 billion in November 2016, declining to $1.91 billion by year end 2016. Short interest remained constant for all of January, but has jumped $298 million, or 17% in the last week as AZO’s stock price has declined 8.77% in 2017. Autozone’s short interest is now up to $2.08 billion, a historical high. Short interest has averaged $1.88 billion in 2017 and short sellers have recouped their 2016 losses with $157.8 million in net of financing mark to market profits so far this year for a net return of 8.37%.

Short sellers are re-entering the Autozone trade as the possibility of import tariffs, possibly up to 20%, on foreign made aftermarket auto parts and accessories may drive Autozone’s cost of goods up significantly and force them to raise prices in order to maintain margins. If Autozone’s prices do increase, its brick and mortar stores may become more of a parts showcase for customers before they search for and purchase from the cheapest vendor on the internet.

Auto parts retailers such as Autozone, Advance Auto Parts (AAP US) and O’Reilly Automotive (ORLY US) have continuously been fighting off the threat of internet competition from smaller and niche product online sellers, but Amazon (AMZN US) has recently announced they will be entering the almost $70 billion auto parts sector. The brick and mortar retailers were able to keep margins high by maintaining exclusive or long term deals with auto parts manufacturers to keep their cost basis as low as possible, but Amazon has stepped in and signed distribution contracts with many manufacturers, which would hurt the effectiveness of these existing deals. With Amazon offering free or same day delivery on much of their inventory, even the convenience of immediate pickup at the local retail shop is becoming less important.

All three major auto parts retailers are down over 5% this year, but short sellers have been turning their attention more towards Autozone than O’Reilly or Advanced Auto. O’Reilly Automotive is down 5.23% in 2017 with a short interest of $1.65 billion, but shorts have bought to cover $114 million, or 6%, of their outstanding positions since the beginning of the year. Advance Auto is the second worst performer of the three this year, down 7.19% in 2017, but with short interest of only $705 million, they are the least shorted of the three. Shorts have also been buying to cover AAP with short interest down $137 million, or down 16%.

The specter of Amazon doing to the auto parts sector what they did to the book, electronics and apparel industries reinvigorated short selling in Autozone. As Amazon establishes its foothold and grows market share, Autozone should see continued short interest. If Amazon becomes the cheapest purveyor in the auto supply sector through its economies of scale, we may also see an increase in short interest in O’Reilly Automotive and Advanced Auto Parts as the entire sector’s profitability and market share will be in jeopardy.

For more information on the above analysis, please contact:
Ihor Dusaniwsky, Head of Research, S3 Partners, LLC     Ihor.Dusaniwsky@S3Partners.net
The information herein (some of which has been obtained from third party sources without verification) is believed by S3 Partners, LLC ('S3 Partners') to be reliable and accurate. Neither S3 Partners nor any of its affiliates makes any representation as to the accuracy or completeness of the information herein or accepts liability arising from its use. Prior to making any decisions based on the information herein, you should determine, without reliance upon S3 Partners, the economic risks and merits, as well as the legal, tax, accounting and investment consequences, of such decision.

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