Advance Auto Parts Inc. (NYSE: AAP) has certainly found the integration of Carquest stores to be a much-harder job than it originally expected, but the new management team has started off by giving investors what they want. Is this a sign that the company has finally turned the corner? And is it now ready to catch up with its sector peers AutoZone, Inc. (NYSE: AZO) and O'Reilly Automotive (NASDAQ: ORLY)?
Continue Reading Below
Image source:WhisperToMevia commons.wikimedia.com
The investment pitch
Followers of the company will be familiar with the investment pitch. Simply put, the hope is that Advance Auto Parts can "pull an O'Reilly Automotive" and succeed with the Carquest integration, thereby establishing itself as a leading dual-store (DIY and do-it-for-me, or DIFM) retailer.
Moreover, there is a huge opportunity for the company to generate operational improvements and get to the kind of operational metrics enjoyed by O'Reilly Automotive and AutoZone. Operating margin, cash flow generation, sales per employee, inventory management, etc. -- you name a metric and Advance Auto Parts probably lags in it.
In other words, the company has a lot of earnings growth potential merely from catching up to its peers.
Continue Reading Below
Not getting better, but not getting worse
Unfortunately, it's not been plain sailing, and same-store sales growth has lagged that of its peers, while operating margin is seemingly in a downward trend. So what exactly was it about the recent third-quarter results that got the market so excited?
I think there were two key takeaways that prompted the market's reaction:
- For the first time in a long while, same-store sales growth came in better than expected.
- Management fleshed out a long-term outlook, which, if achieved, is bullish for the stock.
Let's tackle each point in turn. As you can see below, the same-store sales decline of only 1% was the best result in three quarters. CEO Tom Greco claimed that "to date, our investments have driven sales performance at a faster rate than expected" -- some good news at last.
AUTOZONE FIGURES ARE DOMESTIC SAME-STORE SALES AND ARE TO THE MOST RECENT COMPARABLE QUARTER. O'REILLY FIGURES ARE COMPARABLE SAME-STORE SALES. DATA SOURCE: COMPANY PRESENTATIONS.CHART BY AUTHOR.
The key points from the company's earnings report included:
- Positive comparable-sales growth in 2017 and "modest increase in operating margin"
- Mid-single-digit comparable-sales growth by 2021
- Improvement of 500 basis points in operating margin by 2021
- $500 million in gross productivity over the next five years
To put these figures into context, analysts are forecasting $9.63 billion in sales for 2017 and assuming linear growth to a rate of 4% per annum in 2021, meaning revenue could be around $10.9 billion in 2021. Using the adjusted operating income margin of 9.7% in the third quarter as a base suggests that operating income margin could be 14.7% in 2021.
In other words, operating income could be $1.6 billion in 2021. In contrast, the average ratio of market cap to operating income for O'Reilly Automotive and AutoZone currently stands at 13.2, and using this figure means Advance Auto's market cap would be $21.1 billion in 2021, representing a 72% increase from today's $12.25 billion.
Three reasons to be optimistic
Of course, all of this sounds wonderful, but the previous management clearly thought it had a handle on the integration process as well. What makes things different this time?
There are three key signs that the current management might make a better fist of it.
First, although he was light on the details (for competitive reasons), Greco signaled that management now has a coherent and clear strategy in place, rather than reacting to difficulties created by the integration as the previous management appeared to be doing.
Second, as you can see in the chart below, the pace of consolidations (Carquest stores are consolidated with nearby Advance Auto Parts stores) has slowed. Greco's words offered details: "We dramatically reduced them by about a third, based on what we originally planned at the time of the deal itself." Meanwhile, conversions (Carquest stores are turned into Advance Auto Parts stores) have been "much more successful overall," according to Greco.
It's possible the disruptions caused by the pace of previous consolidations caused the faltering sales growth, and now the rate of consolidations is being slowed, Advance Auto Parts might get back to same store sales growth.
DATA SOURCE: ADVANCE AUTO PARTS INC. PRESENTATIONS. CHART BY AUTHOR.
Third, it appears that management previously overemphasized daily replenishment to stores in the Northeast. According to Greco, "We had more stores than we should have assigned to them, at a delivery frequency that was very difficult for them to execute flawlessly."
Shifting the distribution centers toward delivery three times a week has led to "much better fill rates, like significantly better, much better accuracy, and the general managers are much happier, and they're selling more," Greco added.
OLD CARS REQUIRE MORE MAINTENANCE -- GOOD NEWS FOR ADVANCE AUTO PARTS INC. IMAGE SOURCE: GETTY IMAGES.
Time to buy Advance Auto Parts stock?
All told, there is evidence to support the belief that eliminating previous mistakes with the integration will help matters significantly. Meanwhile, the long-term value opportunity remains in place. Clearly, the company has a long way to go before reaching the kind of performance achieved by O'Reilly Automotive and AutoZone, but this quarter's results and outlook act as a tentative marker for better days ahead.
10 stocks we like better than Advance Auto Parts
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*
David and Tom just revealed what they believe are the ten best stocks for investors to buy right now... and Advance Auto Parts wasn't one of them! That's right -- they think these 10 stocks are even better buys.
Click here to learn about these picks!
*Stock Advisor returns as of November 7, 2016
Lee Samaha has no position in any stocks mentioned, butintends to initiate a position in AdvanceAuto Parts in the coming days.The Motley Fool owns shares of O'Reilly Automotive. The Motley Fool recommends AutoZone. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.