The Good And Bad: O’Reilly Automotive And Kirby Corporation

NEW YORK, NY – AUGUST 25: A trader is reflected in a market screen on the floor of the New York … [+] Stock Exchange (NYSE) on August 25, 2015 in New York City. Following a day of steep drops in global markets, the Dow Jones industrial average rallied early in the day only to fall over 200 points at the close. (Photo by Spencer Platt/Getty Images)

Getty Images

Recap From May’s Picks

The Most Attractive Stocks (+1.4%) outperformed the S&P 500 (+0.8%) from May 5, 2021 through June 1, 2021 by 0.6%. The best performing large cap stock gained 12% and the best performing small cap stock was up 30%. Overall, 21 out of the 40 Most Attractive stocks outperformed the S&P 500.

The Most Dangerous Stocks (+3.9%) underperformed the S&P 500 (+0.8%) as a short portfolio from May 5, 2021 through June 1, 2021 by 3.1%. The best performing large cap stock fell by 3% and the best performing small cap stock fell by 8%. Overall, 10 out of the 26 Most Dangerous stocks outperformed the S&P 500 as shorts.

The Most Attractive/Most Dangerous Model Portfolios underperformed as an equal-weighted long/short portfolio by 1.3%.

13 new stocks make the Most Attractive list this month, and 13 new stocks fall onto the Most Dangerous list this month. June’s Most Attractive and Most Dangerous stocks were made available to members on June 3, 2021.

My Most Attractive stocks have high and rising returns on invested capital (ROIC) and low price to economic book value ratios. Most Dangerous stocks have misleading earnings and long growth appreciation periods implied by their market valuations.

Most Attractive Stocks Feature for June: O’Reilly Automotive, Inc. (ORLY)

O’Reilly Automotive, Inc. is the featured stock from June’s Most Attractive Stocks Model Portfolio.

O’Reilly grew revenue by 8% compounded annually and net operating profit after-tax (NOPAT) by 15% compounded annually over the past decade. Longer term, O’Reilly grew NOPAT by 19% compounded annually over the past 20 years.

The firm’s NOPAT margin increased from 9% in 2010 to 18% over the trailing twelve months (TTM), while its invested capital turns increased from 1.1 to 1.9 over the same period. Rising margins and invested capital turns drive an improvement in O’Reilly’s ROIC from 10% in 2010 to 33% TTM.

Over the past five years, O’Reilly generated $6.5 billion (18% of market cap) in cumulative free cash flow (FCF). Over the TTM, O’Reilly has generated $3 billion in FCF.

Figure 1: Revenue & NOPAT Since 2010

Revenue & NOPAT Since 2010

New Constructs, LLC

ORLY Is Undervalued

At its current price of $528/share, ORLY has a price-to-economic book value (PEBV) ratio of 0.8. This ratio means the market expects O’Reilly’s NOPAT to permanently decline by 20%. This expectation seems overly pessimistic for a firm that has grown NOPAT by 14% compounded annually over the past five years.

Even if O’Reilly’s NOPAT margin falls to 16% (equal to its three-year average, compared to 20% TTM) and the firm grows revenue by just 3% compounded annually for the next decade, the stock is worth $697/share today – a 32% upside. See the math behind this reverse DCF scenario. Should O’Reilly grow profits in line with historical levels, the stock has even more upside.

Critical Details Found in Financial Filings by My Firm’s Robo-Analyst Technology

Below are specifics on the adjustments I make based on Robo-Analyst findings in O’Reilly’s 10-K and 10-Q:

Income Statement: I made $307 million of adjustments, with a net effect of removing $194 million in non-operating expenses (2% of revenue). You can see all the adjustments made to O’Reilly’s income statement here.

Balance Sheet: I made $528 million of adjustments to calculate invested capital with a net decrease of $224 million. One of the most notable adjustments was $102 million in operating leases. This adjustment represented 2% of reported net assets. You can see all the adjustments made to O’Reilly’s balance sheet here.

Valuation: I made $7.3 billion of adjustments with a net impact of decreasing shareholder value by $6.6 billion. Apart from total debt, which includes the operating leases mentioned above, one of the most notable adjustments to shareholder value was $367 million in excess cash. This adjustment represents 1% of O’Reilly’s market cap. See all adjustments O’Reilly’s valuation here.

Most Dangerous Stocks Feature: Kirby Corporation KEX

Kirby Corporation (KEX) is the featured stock from June’s Most Dangerous Stocks Model Portfolio.

Kirby Corporation’s economic earnings, the true cash flows of the business, fell from $94 million in 2014 to -$276 million over the TTM. The firm’s NOPAT margin fell from 14% in 2014 to 4% TTM, while invested capital turns fell from 0.7 to 0.3 TTM over the same time. Falling NOPAT margins and invested capital turns drive Kirby Corporation’s ROIC from 10% in 2014 to 1% TTM.

Figure 2: Economic Earnings Since 2014

Economic Earnings Since 2014

New Constructs, LLC

KEX Provides Poor Risk/Reward

Despite its poor fundamentals, KEX is still priced for significant profit growth and is overvalued.

To justify its current price of $66/share, Kirby Corporation must improve its NOPAT margin to 7% (three-year average vs. 4% TTM) and grow NOPAT by 13% compounded annually for the next decade. See the math behind this reverse DCF scenario. Given Kirby Corporation’s fell 10% compounded annually from 2014 to 2019 before the COVID-19 pandemic, I think these expectations are overly optimistic.

Even if Kirby Corporation improves its NOPAT margin to 7% and grows NOPAT by 8% compounded annually for the next decade, the stock is worth just $30/share today, a 55% downside to the current stock price. See the math behind this reverse DCF scenario. This scenario assumes Kirby Corporation grows revenue by 6% (equal to consensus revenue estimate CAGR of 6% through 2022) compounded annually over the next 10 years. Should Kirby Corporation’s revenue grow at a slower rate, the stock has even more downside.

Each of these scenarios also assumes Kirby Corporation is able to grow revenue, NOPAT, and FCF without increasing working capital or fixed assets. This assumption is unlikely but allows us to create best-case scenarios that demonstrate how high expectations embedded in the current valuation are.

Critical Details Found in Financial Filings by My Firm’s Robo-Analyst Technology

Below are specifics on the adjustments I make based on Robo-Analyst findings in Kirby Corporation’s 10-K and 10-Q:

Income Statement: I made $850 million of adjustments, with a net effect of removing $393 million in in non-operating expenses (3% of revenue). You can see all the adjustments made to Kirby Corporation’s income statement here.

Balance Sheet: I made $792 million in adjustments to calculate invested capital with a net increase of $620 million. One of the largest adjustments was $626 million in asset write-downs. This adjustment represented 11% of reported net assets. You can see all the adjustments made to Kirby Corporation’s balance sheet here.

Valuation: I made $2.3 billion in adjustments with a net effect of decreasing shareholder value by $2.3 billion. There were no adjustments that increased shareholder value. Apart from total debt, the most notable adjustment to shareholder value was $607 million in net deferred tax liabilities. This adjustment represents 15% of Kirby Corporation’s market cap. See all adjustments to Kirby Corporation’s valuation here.

Disclosure: David Trainer, Kyle Guske II, and Matt Shuler receive no compensation to write about any specific stock, style, or theme.