Is Advance Auto Parts Stock a Buy?

Is Advance Auto Parts stock a buy? With attractive valuation, sales of used cars going up, number of miles driven gathering pace, and more older vehicles on the road, Advance Auto Parts could be a great addition to your investment portfolio.

Advance Auto Parts [NYSE: AAP] is a leading automotive aftermarket parts provider that engages in the supply and distribution of aftermarket automotive products for both, commercial and do-it-yourself customers, as well as independently-owned operators. 

The company was founded by Arthur Taubman in 1929 and is headquartered in Raleigh, North Carolina. Advance Auto Parts is the second largest auto parts and accessories retailer in the United States, just behind AutoZone [NYSE: AZO], which is the nation’s leading retailer and a leading distributor of automotive replacement parts and accessories with more than 6,000 stores in the US, Mexico, Brazil and Puerto Rico.

Advance Auto Parts operates through five segments:

  • Northern Division,
  • Southern Division,
  • Carquest Canada,
  • Independents; and

AAP operates more than 5,100 stores across the United States, Canada, Puerto Rico and the Virgin Islands under four brands – Advance Auto Parts, Carquest Auto Parts, WORLDPAC and Autopart International. 

Advance Auto Parts also serves independently-owned Carquest-branded stores across Mexico and various Caribbean Islands, in addition to the locations mentioned above.

Plus, it offers a broad selection of replacement parts, performance parts, private label automotive replacement parts, accessories, oil and fluids, engine parts, brakes, batteries, maintenance items and tools and garage for domestic and imported cars, vans, sport utility vehicles, in addition to light and heavy-duty trucks.

Clearly, it’s got a lot under its umbrella but is the stock a good investment?

Is Advance Auto Parts Stock A Buy?

AAP operates in the auto parts stores industry.  Firms operating in this industry primarily sell new and used automotive parts and accessories parts, batteries and maintenance items, and may offer installation services as well.

This industry, in the past half-decade or so, has experienced steady, albeit slow, growth. Economic expansion led to enhanced levels of per capita disposable income, which, in turn, allowed consumers to be more liberal with their spending on industry services. 

Additionally, the increasing average age of the vehicle fleet, and more miles driven leads to more wear and tear, which, in turn, requires more frequent maintenance and repairs. This also increases likelihood of accidents. All this is good news for auto parts retailers as it bolsters demand for industry products.

There’s no doubt that the current short-term outlook of the industry does not inspire much confidence owing to the uncertainty induced by the pandemic’s recessionary effects. However, experts are confident about the industry making a recovery in the near future, as gradual resumption of economic activity will allow the industry to recuperate from the setbacks dealt by the pandemic.

The auto parts stores industry is expected to put up a strong show as the current situation improves and consumer confidence returns to growth.

Promising new vaccines in the market should lead to economic expansion and more per capita disposable income. This will allow more consumers to afford industry services.

Also, with the passage of time, vehicles will clock more miles and grow older. As a result, they will experience more wear and tear, resulting in more vehicles that require industry products.

There are signs that the dark clouds that were shrouding the industry in uncertainty are dispersing, a fact attested by Advance Auto Parts better-than-expected third-quarter earnings. The auto parts retailer earned $147.5 million, or $2.81 EPS, for the quarter, topping the consensus estimate of $2.66.

Revenue rose 9.9% to $2.54 billion on a year-over-year basis, while analysts were expecting revenue of $2.48 billion. Same-store sales jumped 10.2%, against analyst estimate of 7.2%.

The company’s CEO, Tom Greco, said that the increase in comparable-store sales “is the strongest in 15 years, and was led by our DIY Omnichannel performance. Double digit comp sales, combined with disciplined cost control, resulted in a 95% increase in quarterly free cash flow.”

The quarter topped analysts’ expectations on both profit and revenue front. AAP attributed the strong showing to growth in its do-it-yourself omnichannel platform, as more consumers increasingly opted for do-it-yourself (DIY) rather than enlisting the services of industry operators.

Additionally, economic contraction enforced by the pandemic compelled many people to repair and maintain existing vehicles rather than purchase a new one. This again benefitted AAP.

Better yet, analysts are upgrading Advance Auto Parts, buoyed by a number of signs which show that stock performance is only going to gather more momentum from here. During periods of recession, consumers hold their purse strings more tightly, spending only on items that are absolutely essential.

With unemployment at an all-time high, people are generally going to put off buying a new vehicle for a more favorable time, choosing instead to continue with their old ones, which means more trips to the auto-parts store.

Additionally, AAP putting up a strong show is more commendable given the fact that Advance Auto stores are concentrated more in hard-hit areas in the Northeast. The company’s performance as such is only expected to accelerate from here as the threat of the pandemic starts to recede with widespread availability of vaccines.

Of course, we’re not quite there yet, and with the country in the grip of a fresh Covid wave, a lot of people are still working from home. It means less vehicle usage and less miles travelled, but experts argue that the auto-parts retailers can draw solace from the fact that typical DIY (do it yourself) and DIFM (do it for me) customers are still more likely to commute to their workplace.

And the icing on the cake is avoidance of mass-transit and ride-sharing services by people, which means even more tailwinds for auto-parts retailers.

Analysts opine that these trends are likely to remain strong as the general population getting the vaccine is at least months away, and the used car market is expected to continue with its precipitous growth.

All in all, the tailwind of the pandemic and economic downturn will continue to support the industry, which means AAP can again deliver above expectations in times to come.

AAP Earnings Guidance Poses A Concern 

Despite reporting robust top and bottom-line results for 3Q, Advance Auto refrained from reinstating or updating full-year 2020 guidance, which it withdrew in April, citing uncertainty and continued volatility induced by the Covid-19 pandemic.

One possible reason for the company’s hesitation to reinstate its full-year guidance, notwithstanding better-than-expected third-quarter earnings, could be the additional $9 million in costs that the company has faced related to the pandemic.

Also, there seems to be a bit of an uncertainty as to what the vaccines and subsequent economic recovery would mean for the company. A return to economic growth and cheap gasoline prices may increase vehicle miles driven.

However, a robust pace of recovery may tempt consumers to opt for new vehicles which may not be such a great news for AAP. As such, investors would be wise by  good  keeping an eye out for car sales data. 

If it is weak, it’s probably encouraging news for Advance Auto. But for now, there’s bound to be lingering concerns about what a reopened economy would mean for the business.

Also, it is worth mentioning that Advance Auto Parts carries a significant amount of debt on its balance sheet, which could increase investors’ concerns. 

The company has also long been mismanaged due to hyper-growth (including unintegrated M&A) and underinvestment. For example, the market cheered when AAP announced its acquisition of General Parts International.

Both investors and management had high expectations from the commercial and financial profile of the integrated businesses. However, the integration proved to be a damp squib and the expected ‘increased operational efficiencies driving cost synergies’ failed to materialize.

Are Advance Auto Parts Competitors a Threat?

Advance Auto Parts is a retailer and distributor of automotive parts and accessories. Companies that are the main competitors of Advance Auto Parts in the sub-industry of “automotive retail” are O’Reilly Automotive [ORLY] and AutoZone [AZO].

Other competitors in the consumer discretionary sector include: CarMax [KMX], Lithia Motors [LAD], AutoNation [AN], and U.S. Auto Parts Network [PRTS].

The pandemic-induced lockdown in March of 2020 slammed many businesses and O’Reilly was no exception. However, the business gained momentum in the middle of 2020 once consumer spending picked up as stimulus cheques and enhanced unemployment benefits started reaching Americans.

The automotive aftermarket-parts retailer posted impressive results in both the second quarter of 2020 and the third quarter.

The specialty retailer reported $7.07 EPS for the quarter on a revenue of $3.21 billion. The consensus estimate was $6.34 EPS on a revenue of $2.98 billion.

Comparable-store sales grew by 16.2% and 16.9%, respectively over the prior-year periods in both the second and third quarter. The initial momentum was provided by do-it-yourself (DIY) customers, though the do-it-for-me (DIFM) segment picked up as well.

It was particularly encouraging for the company, given the fact that the DIFM customer is someone who can probably work from home. It meant the lower number of miles driven was compensated for by consumers’ willingness to spend on their automobiles.

O’Reilly, over the past few years till 2019, has been consistently opening 200 new stores. The pandemic in 2020, to some extent, slowed down the pace, with the retailer opening just over 160 new stores.

CFO Tom McFall still thinks the company is well on track to obtain its objective of reaching 6,500 stores in the US, a substantial increase from the current 5,592 domestic locations.

It’s good news for investors as it means there’s plenty of room sill left for the business to expand.

Also, an important thing to note here is that, despite two record-breaking quarters, O’Reilly stock ended 2020 up just 3.3% on the year, thus providing investors with a lucrative opportunity to add this stock to their portfolio at attractive prices. Also, O’Reilly Automotive has higher revenue and earnings than Advance Auto Parts.

AutoZone, like O’Reilly, too, has benefitted from the pandemic-driven boom. A spike in sales of used cars during the crisis, as people preferred their own private vehicles instead of opting for public transportation, hugely benefitted the automotive part company.

Meanwhile, economic stress, too, was a tailwind as consumers opted to stick to their old vehicles rather than choosing to purchase a new one.

The company, in its latest quarters, topped both profit and revenue consensus by a fair margin. It reported $18.61 EPS for the quarter on a revenue of $3.15 billion. Analysts expected $17.72 EPS on a revenue of $2.85 billion. The firm’s revenue for the quarter was up 12.9% on a year-over-year basis.

Also, similar to O’Reilly, AutoZone also seems to have benefited from government stimulus. Management said the recessionary climate favors the company going forward, with the CEO William Rhodes stating that:

“…we continue to believe our customers will focus more on maintaining their current vehicles, and it will benefit our business — retail in particular — as it has in the last three recessions. Its sales have historically been strongest coming out of recessions like in 2009 to 2011 and 2001 to 2002”.

Moreover, vehicle miles are likely to rebound with the gradual reopening of the economy, prompting more repairs. Despite a stellar performance and clocking double-digit comparable-sales growth, AZO is tempting investors with its cheap valuation.

Advance Auto Parts trails AutoZone by a fair margin when it comes to revenue and earnings.  Additionally, AutoZone is trading at a lower price-to-earnings ratio than Advance Auto Parts, meaning it has a more attractive valuation than AAP.

Is Advance Auto Parts Stock A Buy: The Bottom Line

Companies operating in the automotive aftermarket sector benefit primarily from three factors. They are enumerated as follows:

Number of miles driven in the country

This is probably the most important factor. Stock of firms like AAP are natural beneficiaries of more miles driven than new vehicles sold as more the vehicle travels, more is the need for repair and maintenance owing to increased wear and tear.

As per the data, number of miles travelled in the US roughly equal three trillion miles per year. This figure, however, took a severe hit as the pandemic forced people indoors, which drastically reduced the number of miles travelled.

The encouraging thing for automotive parts retailers such as Advance Auto Parts is that the number of miles driven has been going up with the gradual reopening of the economy. 

Size of vehicle fleet on the road

The next most important factor for auto-parts retailers is the size of the vehicle fleet on the road. It currently stands over 270 million which, again, is great news for AAP. 

In a way, the fortune of companies like AAP are inversely tied to sales of new vehicles. People generally avoid big-ticket purchases like cars during periods of economic contraction, which again benefited Advance Auto.

The company derives its business from a vehicle that is more than five to six years old and, as such, outside of the manufacturer’s warranty period. 

The growth witnessed by the used car market benefitted AAP in a major way as older cars, when driven more, ultimately need more maintenance and repair. In fact,

business is booming for used car dealers like Carvana and Vroom, both of which have been unable to keep pace with the rising demand.  This trend is likely to continue as the US struggles with the rollout of its vaccine program.

Better-engineered vehicles

Automobiles manufactured today come equipped with advanced technological tools, state-of-the-art engines and sturdier body. All these factors significantly prolong the average age of the domestic vehicle fleet, which currently averages close to 12 years.

Consumers, as such, feel less need for a new car when their old vehicle is doing perfectly fine, which, in turn, leads to strong demand for companies like Advance Auto Parts. 

The electric-vehicle giant Tesla’s stock has been on an unrelenting ascent, and with grave pollution concerns, it is perceived that EVs will completely replace gasoline-driven cars in near future. However, with EVs projected to only have 7.6% share of new car sales in the next five years or so, we are still several decades away from EVs dominating our streets.

It means automotive aftermarket retailers like AAP are going to stay and remain relevant for many more years to come. 

The weather, too, is expected to help AAP this year. Car breakdowns occur more in the winter, and the winter of 2020 was the third warmest winter since 1950. Lack of snow in the Northwest tampered with Advance Auto Part’s business, but a slightly colder weather this year could help the company.

Also, the stock is pretty cheap and the compelling valuation should be a tempting factor for investors to purchase shares of this recession-resilient business. And with air travel out of favor with travelers, and all-time low gasoline prices encouraging people to drive more, this auto parts retailer looks a compelling buy.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.