Will Advance Auto Parts Stock Recover?

Advance Auto Parts (NYSE:AAP) has had a truly dismal year, plunging 62% year-to-date, a vast underperformance relative to the S&P 500, which is up 13.97% for the year.

Technically, the weekly chart looks awful but the daily is starting to show signs of life. Is there a fundamental reason why a bullish trend should begin and the stock will bounce back or should AAP be written off as a prospective opportunity?

What’s Been Weighing on AAP Stock?

Advance Auto Parts has been operating for some time with a significant debt burden that has been anchoring it to ever lower prices. Currently, the balance sheet has just $277.1 million in cash versus $1.7 billion in debt.

To understand the gravity of that situation, imagine having $10,000 in your bank account but $60,000+ in debt to service at a time when interest rates are on the rise. 

The severity of the situation is largely a function of what income you make, or in the case of AAP what revenues it generates. And there, shareholders can find some bright spots.

The quarterly top line has ranged from $2.4 billion to $3.4 billion over the past four quarters. Better yet, the operating income has been in the black the whole time, spanning a quarterly low of $90.0 million and a high of $184.2 million. That consistency shows the company can adequately service its debt burden, in spite of the liability being fairly lopsided relative to liquid reserves.

With all that said, what has shareholders in a funk is the lack of growth in revenues, which have largely been flat for a couple of years now. Worse still, earnings per share have generally fallen from above $2 per share for most quarters in 2022 to around $1 and change per share for most quarters in the past fiscal year.

Such a rapid decline in earnings is sufficient cause for institutional and retail investors alike to run for the exits, and so they have.

But are there bright spots up ahead for Advance Auto Parts to ignite a bounce back higher?

Will Advance Auto Parts Stock Recover?

No doubt, the profit-and-loss statement in conjunction with the balance sheet have made AAP shareholders nervous to stick with the position, triggering four analysts to revise their earnings downwards for the upcoming period.

But a clue as to where the company is likely headed can be found in the authorization by AAP’s Board to repurchase shares. 

Clearly, insiders are assessing the company to be on sale and, even more so, have demonstrated confidence by raising the dividend over the past three years. As an aside, AAP dividend yield is currently 1.75%.

In spite of the drawbacks, the good news appears to be permeating into the markets with the share price climbing 4.77% over the past week.

So, will Advance Auto Parts stock recover? Advance Auto Parts is highly likely to recover according to the consensus estimate of 19 analysts who have a price target of $67.75 per share. If they are proven correct, that share price forecast would correspond to a 20.8% move higher.

It’s worth noting that a discounted cash flow forecast analysis validates the bullish thesis but is less optimistic in placing intrinsic value at $64.75 per share, translating to a potential 13% increase in share price from current levels.

Another noteworthy figure to keep in mind is AAP’s price-to-earnings ratio which sits at 9.8x, a relatively modest level for most any company but particularly one with a market capitalization of just $3.3 billion and room to grow.

Things To Know Before Buying

While a valuation analysis generally sides with the bulls, prospective buyers should keep a close eye on a few key line items and metrics.

The first and perhaps most important is the top line, which simply isn’t growing in any meaningful fashion, if at all in most quarters. Secondly, the company has a pretty poor return on invested capital of just 6.2%, suggesting that AAP has no real moat to rely upon.

The lack of a moat generally means the company lacks a competitive advantage, for example one that would permit premium pricing to squeeze out higher margins. Further concerns are the paltry 2.8% return on assets and 3.1% net income to common margin. 

Pair those with the elevated debt levels and modest liquid reserves and you end up with a company that certainly has a place in the market but not one that eclipses the forces of commoditization. 

Could AAP share price power higher? Value buyers appear to be scooping up shares at current prices and driving AAP share price higher short-term but the weekly trend looks decidedly weak still.

Wrap-Up

Advance Auto Parts has demonstrated short-term strength, breaking out of a pattern of lower lows and lower highs recently, but its medium term weekly chart pattern remains concerning for bulls.

A valuation argument is perhaps the most compelling reason to buy the stock with analysts forecasting fair value sits about 20% higher. 

It does appear that bargain hunters are stepping in now, perhaps because the negative news of stagnating revenues and elevated debt levels have been priced in.

Nonetheless, the low ROIC and ROA metrics signal that Advance Auto Parts lacks a meaningful competitive advantage to sustain higher prices over the long-term.

Certainly, momentum buying could power the stock higher in the short-to-medium term but to recover to old highs will be a stretch absent some significant fundamental event that can re-ignite revenue growth and in turn profitability.

Ultimately, AAP is a Hold for shareholders who have been on the ride down for some time and may be on the cusp of turning the corner to higher prices. But prospective buyers may wish to adopt a wait-and-see approach until the company can demonstrate a clear strategy to ignite sustained increases in the top line that are needed to excite deep-pocketed investors.

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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.