Description
I recommend a short position in the publicly-traded equity of Monro Muffler Brake (NASDAQ: MNRO).
Monro is a chain of over 800 stores providing automotive undercar repair (% of revenue: brakes – 18%; exhaust – 5%; steering – 10%; maintenance – 28%) and tire services (39% of revenue) in 19 states in the northeast and mid-atlantic U.S.
The Lesser Depression has distorted the auto market in the United States. Amid high unemployment, underwater household balance sheets, and economic uncertainty, consumers have delayed purchasing new cars in favor maintaining and repairing their existing cars. New vehicle sales and vehicle scrappage rates have both been well below normalized levels for the past several years. As a result, the population of older cars in operation has experienced a temporary bulge relative to the overall number of vehicles in operation.
Auto maintenance expenses increase substantially around the fourth year of operation, so aftermarket auto parts and service retailers have benefitted to varying degrees from this shift in the makeup of the U.S. auto population. The benefit that Monro Muffler derived from this shift is plainly evident from even a cursory glance at its comparable store sales history.
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Comps |
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| 2000 |
-1.6% |
| 2001 |
-1.4% |
| 2002 |
0.3% |
| 2003 |
2.9% |
| 2004 |
4.7% |
| 2005 |
2.0% |
| 2006 |
1.7% |
| 2007 |
3.2% |
| 2008 |
1.2% |
| 2009 |
6.7% |
| 2010 |
7.2% |
| 2011 |
4.2% |
| 2012 |
2.0%
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But this distortion in the auto market is temporary, and the auto market is already well on its way to normalizing. Assuming continued modest progress towards a normalized auto market, the population of cars in Monro’s “sweet spot” should decline over the next several years.
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Total Vehicles
in Use |
New Vehicle Registrations |
Scrappage |
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Estimated > 4 Years Old |
% of Total |
Growth |
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ACTUAL |
1993 |
186,315,464 |
13,209,549 |
8,413,235 |
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- |
- |
- |
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1994 |
188,713,997 |
14,767,042 |
12,368,509 |
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- |
- |
- |
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1995 |
193,440,393 |
15,058,699 |
10,332,303 |
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- |
- |
- |
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1996 |
198,293,459 |
15,663,707 |
10,810,641 |
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139,594,462 |
70.4% |
- |
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1997 |
201,070,397 |
15,285,529 |
12,508,591 |
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140,295,420 |
69.8% |
0.5% |
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1998 |
205,042,639 |
15,637,540 |
11,665,298 |
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143,397,164 |
69.9% |
2.2% |
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1999 |
209,509,161 |
16,130,124 |
11,663,602 |
|
146,792,261 |
70.1% |
2.4% |
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2000 |
213,299,313 |
18,088,911 |
14,298,759 |
|
148,157,209 |
69.5% |
0.9% |
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2001 |
216,682,936 |
17,505,343 |
14,121,720 |
|
149,321,018 |
68.9% |
0.8% |
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2002 |
221,027,121 |
17,639,934 |
13,295,749 |
|
151,662,809 |
68.6% |
1.6% |
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2003 |
225,882,103 |
16,939,662 |
12,084,680 |
|
155,708,253 |
68.9% |
2.7% |
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2004 |
232,167,136 |
17,419,471 |
11,134,438 |
|
162,662,726 |
70.1% |
4.5% |
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2005 |
239,384,168 |
17,287,680 |
10,070,648 |
|
170,097,421 |
71.1% |
4.6% |
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2006 |
244,642,610 |
17,332,357 |
12,073,915 |
|
175,663,440 |
71.8% |
3.3% |
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2007 |
248,700,997 |
16,765,603 |
12,707,216 |
|
179,895,886 |
72.3% |
2.4% |
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2008 |
249,812,723 |
15,127,946 |
14,016,220 |
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183,299,137 |
73.4% |
1.9% |
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2009 |
248,972,046 |
9,589,747 |
10,430,424 |
|
190,156,393 |
76.4% |
3.7% |
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2010 |
248,231,351 |
10,570,877 |
10,628,811 |
|
196,177,178 |
79.0% |
3.2% |
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2011 |
248,931,633 |
12,698,406 |
11,998,124 |
|
200,944,657 |
80.7% |
2.4% |
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FORECAST |
2012 |
250,231,633 |
14,300,000 |
13,000,000 |
|
203,072,603 |
81.2% |
1.1% |
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2013 |
252,231,633 |
15,000,000 |
13,000,000 |
|
199,662,350 |
79.2% |
-1.7% |
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2014 |
254,731,633 |
15,500,000 |
13,000,000 |
|
197,233,227 |
77.4% |
-1.2% |
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2015 |
257,731,633 |
16,000,000 |
13,000,000 |
|
196,931,633 |
76.4% |
-0.2% |
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| Source: National Automobile Dealers Association (Actuals) |
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In addition, consumers are driving their cars less than they were prior to the Lesser Depression, primarily due to the high cost of gas. Less driving translates directly into less demand for maintenance and repairs.
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Vehicle Miles Traveled |
Year-over-Year |
Per Average Vehicle |
Year-over-Year |
| 2000 |
2,747 |
- |
12,994 |
2.5% |
| 2001 |
2,796 |
1.8% |
13,005 |
1.8% |
| 2002 |
2,856 |
2.1% |
13,050 |
2.1% |
| 2003 |
2,890 |
1.2% |
12,933 |
1.2% |
| 2004 |
2,965 |
2.6% |
12,946 |
2.6% |
| 2005 |
2,989 |
0.8% |
12,677 |
0.8% |
| 2006 |
3,014 |
0.8% |
12,454 |
0.8% |
| 2007 |
3,031 |
0.6% |
12,288 |
0.6% |
| 2008 |
2,977 |
-1.8% |
11,944 |
-1.8% |
| 2009 |
2,957 |
-0.7% |
11,857 |
-0.7% |
| 2010 |
2,966 |
0.3% |
11,931 |
0.3% |
| 2011 |
2,931 |
-1.2% |
11,791 |
-1.2% |
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In combination, these two trends – a declining population of older vehicles in operation (as the distortion from the Lesser Depression normalizes) and declining usage per vehicle – should create a material headwind for Monro’s business. Indeed, for the quarter ended in June, Monro reported a 7.2% decline in comparable store sales and 24% decline in operating income. The company attributed the weak performance in part to the impact of a mild winter. While the company’s explanation likely has some truth to it, I believe Monro’s poor recent performance is also evidence of the increasing headwinds the company will face over the next few years.
At $33.46, MNRO is trading at 21.5x LTM earnings per share and over 3x book value. I think MNRO will struggle to maintain its current level of earnings against the headwinds it faces and will also experience multiple compression as investors increasingly appreciate that the company’s strong performance over the past few years is not sustainable. I see downside to below $20 per share from a combination of lower earnings and a lower valuation multiple. As a point of reference, 15.0x LTM earnings of $1.56 would result in a $23 stock. I think there is downside risk to both variables.
Four other points are worth noting:
i) Insiders have been consistent and aggressive sellers of stock.
ii) The CEO recently stepped down and assumed the title of Executive Chairman. While he had been CEO for 13 years, he is also only 54 years old. The skeptic in me interprets the move as recognition of the challenging environment that the company faces over the next few years. The move also may allow him to unload his more than $20 million (at current prices) worth of stock more quickly than he could as CEO.
iii) The company’s practice of exchanging aged inventory for barter credits strikes me as a red flag, particularly because Monro carries several years worth of barter credits as a long-term asset buried in other non-current assets. I question whether these barter credits are really worth carrying value if they take so long to monetize. If they are not worth carrying value, than Monro has arguably overstated income in the past. These aren’t huge dollar amounts, but where there is smoke there is fire...
iv) Monro's sales and margins have been hurt by tire cost inflation. A 25% tariff on tires imported from China recently expired. The expiration of this tariff may provide Monro some relief from the negative impact of tire cost inflation, though I think any benefit Monro derives from this will be more than offset by the unfavorable demand dynamics Monro is facing.
I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.
Catalyst
Weak performance over the next few years