We have upgraded the recommendation on O’Reilly Automotive (ORLY) from Neutral to Outperform. This reflects the company’s improving outlook due to an excellent growth strategy, dual market strategy and a strong distribution network.

O’Reilly has a competitive advantage generated by its heavy mix of commercial sales. The heavy mix provides the company a greater exposure to less discretionary sales of hard parts and the ability to operate in smaller markets. Given its history as a commercial outlet, the company has access to brands that are otherwise not sold through retail channels.

The acquisition of CSK Automotive Corp. has positioned O’ Reilly as a leading auto parts retailer in the U.S. The company expects the deal to modestly boost 2009 earnings and result in about $100 million of annual cost savings starting in 2010. The synergies are expected to come primarily from leveraging the combined company’s buying power to lower product acquisition costs and streamline CSK’s SG&A expense structure by implementing O’Reilly’s dual market strategy.

O’Reilly Automotive has succeeded in beating the Zacks Consensus Estimate as well as management expectations in the second quarter. The company reported earnings per share of 63 cents in the quarter, above the Zacks Consensus Estimate of 55 cents and management’s expectation of 51 cents to 55 cents.

For the full year, O’Reilly expects net earnings of $2.09 to $2.13 per share, higher than the previous year. Revenues are expected to be in the range of $4.8 billion to $4.9 billion, compared to $3.6 billion in 2008. Gross profit is anticipated between 47.4% and 47.8% of sales, up from 45% in 2008, on the back of expected cost synergies in 2009. We have set a target price of $43 for the stock.

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