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Executive Summary
Founded in 1932, and headquartered in Roanoke, VA., Advance Auto Parts, Inc. (AAP)
is the largest automotive aftermarket parts provider in North America. Advance’s stores and
branches offer a broad selection of brand name, original equipment manufacturer ("OEM") and
private label automotive products. Advance’s products include replacement parts, accessories,
batteries and maintenance items for domestic and imported cars, vans, sport utility vehicles,
and light and heavy duty trucks. Advance currently owns and operates 5,372 locations which
include 1,325 CARQUEST branded stores and 100 WORLDPAC branches. With the addition of
WORLDPAC, Advance has also become the leader in imported parts. AAP has a dual-market
structure that reaches both DIY customers as well as commercial customers. Advance’s two
greatest competitors, Auto Zone Inc. and O’Reilly Automotive, Inc. have also demonstrated
consistent growth and earnings. Moreover, AutoZone and O’Reilly have demonstrated
significantly stronger margins than Advance due to differences in industry practice. However,
what sets Advance apart from its competition is their promising future. In October 2013,
Advance acquired General Parts International, Inc. With this acquisition, AAP has increased
their store locations from 4,049 to 5,372 as well as their number of employees to over 41,600.
With availability being a crucial factor for success in the Auto Parts Stores Industry, Advance
Auto Parts has promising future earnings if GPI can be integrated efficiently and if margins can
improve.
Industry Overview
The following factors greatly affect the Auto Parts Stores Industry and directly relate to sales of
companies such as Advance Auto Parts. The industry data is gathered by the Automotive
Aftermarket Industry Association (AAIA) and is published in their annual Factbook.
Average Age of U.S. Light Vehicles
The average age of the vehicles is an important factor that affects sales. As vehicles age
and warranties expire, there is a greater demand for automotive aftermarket products due to
maintenance needs. The average age of vehicles has steadily increased since the early 2000s
– 11.4 years at 2014 year-end (AutoCare Factbook).
The growth of the average age is expected to slow down as a boom of new vehicles to
be purchased is expected. However, the Automotive Aftermarket Industry Association estimates
that growth will still remain with an increase of 2.63%, reaching 11.7 years, by 2019.
U.S. Light Vehicle Population
TheAutomotive Aftermarket Industry Association projects significant growth in light
vehicle sales as well as the light vehicle population. This demonstrates a postive outlook in
terms of a greater potential client base. A greater number of vehicles on the road will result in a
greater demand for vehicle maintenance.
U.S. Miles Driven and Gas Prices
An increase in miles driven results in higher demand for vehicle maintenance which
directly affects sales for the Auto Parts Stores Industry. Additionally, when gas prices are low,
individuals are generally more inclined to drive.
Since the end of the recession, U.S. miles driven has remained flat at just under 3 trillion
while average prices of gas has increased by more than a dollar. Furthermore, record-high gas
prices beginning in 2008 have deterred the growth of miles driven. However, as seen above, an
increase of gas prices slows down the growth of miles driven, but generally does not diminish
the total miles driven annually.
Defensive Stocks
Companies in the Auto Parts Store Industry, particularly AAP and its two biggest
competitors (Auto Zone and O’Reilly), are defensive positions. Before providing evidence to this
assumption, it is important to mention the differences between the following industries – the
Auto Parts Industry and the Auto Parts Stores Industry. First, the Auto Parts industry, which
belongs to the Consumer Goods sector, is comprised of companies that manufacture auto
parts. Second, the Auto Parts Stores industry, which belongs to the Services sector, is
comprised of retail companies that sell auto parts to auto manufacturers, dealership service
centers, mechanics shops, and individual consumers. While both industries are closely related
and revolve around automobiles, economic conditions affect each sector differently. From 2007
until early 2009, the recession resulted in vehicle sales to drop from an average of 17 million, to
just 9 million - a drop of approximately 47%. It would be expected that the stock prices of retail
stores like AutoZone, Advance Auto Parts, and O’Reilly would significantly decline with this drop
of sales. However, the S&P 500 and the Consumers sector were significantly impacted more.
Within the time frame of July 15th, 2007 until March 3rd, 2009 – the worst sell off of the
recession, the S&P 500, the Consumer Discretionary Select Sector, and the three largest
companies in the Auto Parts Industry all performed poorly. The S&P 500 fell 68.92%, the
Consumer sector fell 58.03%, and the top three Auto Parts companies (JCI, BWA, and TRW) all
fell by at least 48%. Yet in that same time period, the top three auto parts retailers
outperformed. Advance Auto Parts only dropped 3.43%, O’Reilly Automotive dropped 7.60%,
and AutoZone went up an astonishing 11.68%. What can be concluded is that while the
consumers sector is cyclical, the auto parts stores industry is relatively counter-cyclical. When
the economy is in recession, such as from 2007-2009, fewer vehicles are purchased by
individuals because of less cash on hand. However, people still need to drive, and cars still
need maintenance. Although an individual does not have the financial means to buy a new
vehicle, he or she will still spend money to get their car fixed. After all, in a time of financial
stress, getting to work to make money is an ultimate priority. According to the most recent
estimates from the American Community Survey, approximately 86% of working Americans
drive to work and only 5% use public transportation. Although miles driven will decrease during
a recession, there will always be enough auto parts needed to keep this industry from going
down with the rest of the economy. As expected, the beta for AAP, AZO, and ORLY are all
below 1. (Advance: 0.85, AutoZone: 0.77, O’Reilly: 0.97)
DIY Market vs. Commercial Market
The Auto Parts Stores Industry has two markets – DIY and Commercial. “Do-it-yourself”
customers can shop at retail locations through walk-ins, pick up merchandise ordered online, or
order purchases to be shipped directly to them. Commercial orders, also known as “Do-it-for-
me”, primarily consist of shipping products from store locations to customers’ places of business
such as independent garages, service stations and auto dealers. Commercial customers also
have the option of conveniently placing their orders online. The Automotive Aftermarket Industry
Association reported in January of 2013 that the DIY market is a 47 billion dollar market, while
the commercial market is a 60 billion dollar market. However, a more relevant statistic is that the
commercial market is growing faster than the DIY market at a ratio of 3 to 1. This significant
growth rate is due to the increase in new vehicle sales with complex designs. In 2014, an
increase of 1 million new vehicles was recorded as compared to the vehicle sales in 2013 (New
York Times). With the complex designs of modern automobiles, a smaller proportion of people
have the ability to fix their cars which has caused the DIY market to shrink. Morgan Stanley
research shows that from 2012 to 2014, the demand for DIY auto has decreased 1.3% while
supply has increased 1.2%.
Competition
Same Store Sales
The Auto Parts Stores Industry has three top companies: Advanced Auto Parts (AAP),
AutoZone (AZO), and O’Reilly Automotive (ORLY). With the exception of a couple years, all
three companies have demonstrated positive same store sales growth over the last ten to fifteen
years.
Total Revenues
All three companies have increased total revenues and are projected to continue doing
so through 2019. AutoZone has historically had the most sales and analysts predict them to
continue leading in this category for years to come.
Expansion
All three of these companies have been out-performing the S&P 500 and have proved
themselves as steady grown companies. Depicted below is an indication of the companies’
availability; the number of retail locations.
AutoZone currently leads the pack with 5,476 stores and has not announced any plans
to open new branches. Advance currently has 5,372 stores - the sharp upward trend in late
2013 is due to the acquisition of GPI. In the 2015 Q1 report, management expressed that they
continue to grow their WORLDPAC brand and plan on opening 12 new stores this year.
O’Reilly, at 4,366 stores, has the least amount of stores but plans on expanding faster than their
competitors. They hope to have opened 205 new locations by the end of 2015. While the
number of locations is important for retail stores, what may be more important than retail
locations are distribution centers and store hubs. As stated earlier, the Auto Parts Stores
Industry is all about availability – the ability to say “yes” to customers as much as possible. By
increasing the number of distribution centers and store hubs, these companies can near daily
replenishment for all of their retail locations. After acquiring GPI, Advance now has 50
distribution centers including the recent addition of a distribution center (DC) in Hartford, CT. Its
competitors, AutoZone and O’Reilly, only have 9 and 25 DC’s, respectively. At the end of 2014,
Advance had more than 420 hub stores, while AutoZone had just 166 and O’Reilly with 283. Not
only does expansion of supply chains increase parts availability, but it also signals growth.
Furthermore, it is important that these companies utilize their expansion efficiently. The table
below addresses the sales per square footage of location – often a good indicator of property
efficiency.
It can be determined that AAP and ORLY are expanding faster than AZO. AutoZone has
significantly higher sales per square footage; however, this is primarily due to the 80% DIY side
of the business. Commercial sales require more distribution centers and hubs which results in
more square footage. For this reason, AutoZone has a smaller supply chain, which results in
greater sales per square footage.
Margins
Since becoming a publically traded company in 2001, AAP has shown positive annual
revenue growth every year. Similarly, AZO and ORLY have also shown positive revenue growth
since 1991. While yielding similar gross margins over the last 15 years, Advance’s operating
margins have been consistently inferior to its top two competitors.
FY2014 AAP AZO ORLY
Sales per Square
Footage 227.14 272.67 228.42
Cash Flow
It is also important to note the free cash flows of each company, relative to the value of
their enterprise.
Advance, AutoZone, and O’Reilly have shown positive FCF/EV at 2014 year-end.
Advance has shown a consistent growth of free cash flow and a Bloomberg consensus
estimates continued growth throughout the next couple of years. With free cash flow estimates
relative to FY2014 enterprise values, Advance is projected to have the greatest growth as well
as yield the superior FCF/EV. Advance’s FY2014 enterprise value was $13.18B with a free cash
flow of 505.1M. FCF for 2015, 2016, and 2017 are expected to be $543M, $866M, and $906M,
respectively.
Debt
The debt-to-assets ratio can be a good measure of the level of risk associated with each
company. A lower percentage indicates less dependence on leverage while a higher percentage
links higher risk due to more debt taken on by the company.
AutoZone has demonstrated both a higher ratio of debt to assets, as well as an upward
trend in their level of leverage. This leads me to believe that relative to Advance and O’Reilly,
AutoZone holds more risk.
Retail Store Impression
After visiting two local Advance stores and two local AutoZone stores, neither chain
stood out as more impressive than the other. I noticed that all four of the stores were very clean
and organized, and the employees were helpful and friendly. Both AutoZone and Advance
employees confirmed that they have training after getting hired, but nothing to extensive. When
discussing wage comparisons, two AutoZone employees noted that Advance tends to pay
better starting wages. When asked about the replenishment of their inventory, all four stores
expressed weekly delivery – not daily. However, an AutoZone employee explained the process
of electronically-notified replenishment of inventory from the most nearby supply hub. Further
research on this matter shows that both chains run this technology throughout its locations. In
regard to the overall process of integrating GPI, Advance employees explained that there have
been no issues associated with their respective store locations. All locations had a similar
amount of employees currently working, in the range of 4-6 employees per shift. However,
further research shows that AutoZone actually has a higher average number of employees per
location than Advance. Below are tables that provide the number of employees per location and
the revenue per employee for fiscal year 2014.
Advance demonstrates the lowest number of employees per location as well as the most
revenue per employee.
Price Comparison
When comparing in-store prices, it is difficult to determine which chain offers the lowest
prices. However, Advance and AutoZone both provide a price-match policy. If a customer finds
a discounted product at another retailer or e-commerce store, both Advance and AutoZone will
match that price, and often give a 5% discount. This strategy keeps AAP and AZO from losing
customers to local stores that reduce prices. O’Reilly does not currently offer a price-match
policy but they ensure customers that they strive to provide the lowest prices possible.
FY2014 AAP AZO ORLY
Employees per
Location 7.12 13.45 7.23
Revenue per Employee 236,631.27 124,675.17 213,626.25
Advance Auto Parts: Company Analysis
Management
Advance Auto Parts is led by a management team with a history of success. This team,
particularly the four individuals below, is confident in the future success of this company.
- Darren Jackson joined Advance as CEO in January of 2008. Prior to this position he
was a member of the Board of Directors. Before working with Advance, Jackson held
various senior positions such as CFO of Carson Pirie Scott & Company and Vice
President and CFO of Best Buy.
- George Sherman joined Advanced as President in April of 2013. Prior to joining
Advance, Sherman spent 15 years at Target where he worked his way from store
manager to Senior Vice President.
- Mike Norona joined Advance shortly after Jackson. In February of 2008, Norona
began working as Executive Vice President and Chief Financial Officer. Prior to
joining Advance, Norona was also employed by Best Buy where he spent 19 years in
various finance positions.
- Bill Carter joined Advance in April 2011. In late 2013, Carter was appointed to Senior
Vice President of Business Development and Integration. Due to the recent
acquisition of General Parts Inc., Carter’s role is particularly important.
Below is the compensation of the management teams for AAP, AZO, and ORLY. Due to
combining management teams with GPI, Advance had a turnover of 12 employees in executive
positions from 2011 to 2013.
Porter’s Five Forces
The bargaining power of suppliers can be classified as relatively low. In 2014, Advance
purchased merchandise from over 500 vendors, with no single vendor accounting for more than
6% of purchases. Advance negotiates prices and delivery dates with companies that they have
had strong relationships with in the past, and will continue to in the future. On the other hand,
the bargaining power of customers is relatively high. Advance has numerous competitors in the
industry that customers can turn to if they feel they are not given the right price. As previously
discussed, Advance avoids this issue with the price-match policy. Similar to the bargaining
power of customers, the threat of substitutes is also relatively high. Retaining clients and
improving customer satisfaction is vital for all companies in the Auto Parts Stores Industry.
Lastly, the threat of new entrants is low. While it is possible for smaller auto parts to grow and
FY2014 AAP AZO ORLY
Total Compensation
Paid 10.4M 13.9M 10.0M
# of Executives
Included in
Compensation 4 5 5
Compensation per
Executive 2.6M 2.78M 2.0M
become a strong competitor over time, it is very difficult for new companies to join the market
and compete with already established companies.
General Parts International Acquisition
AAP’s expansion is primarily due to their most recent acquisition. In January 2nd 2014,
Advance Auto Parts closed the acquisition of General Parts International for a $2.08 transaction
paid for by a combination of cash on-hand and a $1,006M loan – shares were not diluted.
Through this merger, Advanced added $2.9B to their LTM revenue as well as an addition of
17,000 new employees to the company. In the 2014 Investors Day Presentation, Advance’s
CEO, Darren Jackson, outlined the reasoning behind this acquisition. Jackson explains that this
merger overtakes AutoZone and becomes the #1 automotive aftermarket parts provider in North
America. Moreover, it creates the largest business-to-business e-commerce platform and the
leading distributor of import automotive parts. Also, by adding GPI’s commercial platform,
Advance has been able to balance their commercial and DIY sales in a manner more suitable to
the market growth. Prior to this acquisition, Advance’s business was 40% commercial with the
remaining 60% DIY. With the addition of GPI, whose business was 90% commercial, Advances
commercial business increased to 57% as of January 2014. The remaining 43% is DIY
business. With the growth rates of these two markets, this major altercation was an intelligent
decision. Advance’s two greatest competitors have different distributions of sales. 80% of
AutoZone’s sales come from the DIY market, while the remainder comes from commercial.
AutoZone has increased their commercial sales by 15% over the last 5 years and plan to
continue the growth of their commercial market. O’Reilly’s sales are distributed 58% and 42% in
terms of DIY and commercial. ORLY management has estimated that they reach an even 50/50
ratio by the end of the decade.
Furthermore, the addition of GPI delivers scale for AAP. Prior to the acquisition, 88% of
Advance’s stores were east of the Mississippi. Now, with coast-to-coast North American
coverage, Advance is available to new markets and can expand its geographic footprint
efficiently. Furthermore, the acquisition strengthens Advance’s leading brands by combining
team member knowledge and improving Carquest’s capabilities. Most important to
shareholders, Darren Jackson describes this acquisition as financially compelling. Management
estimates that Advance will yield $160M in synergies throughout the first three years post-
acquisition and costs to attain these synergies will total $190M. The synergies over the three
years will primarily be a result of optimizing the supply chain. The costs associated with
attaining these synergies will be due to store conversions, system integration, and customer
retention costs. The goal for the first year of the integration process was $50M in synergies, and
Advance ended with $61M at the end of 2014. The estimates for 2015 synergies are set at a
range of $45M to $55M which remains unchanged in the 2015 Q1 report on May 21st. The most
difficult task that lies ahead for AAP is to attain these synergies while still allowing base
FY2014 AAP AZO ORLY
Commercial 57% 20% 48%
DIY 43% 80% 52%
business to continue without too much disruption. Due to the addition of GPI, Advance
estimates the near completion of daily delivery for the all retail stores by the end of 2017. This
will allow Advance to say “Yes” to customers more often than they ever had. While the
integration process has gone well thus far, several tasks are in need of completion in 2015.
Product brand alignment, pricing, consolidation of store support systems, and consolidation of
store leadership teams are major integration tasks that still remain. President of AAP, George
Sherman, expresses that product labeling, alignment, and pricing is almost complete – he
suggests that just a few touch-ups are needed. With the incredibly large amount of merchandise
throughout the company, this portion of the integration process was long and difficult. The major
tasks that remain in future years revolve around the conversions and consolidations of
locations. This portion of the integration process will understandably go on for a year and a half
to two years. Overall, the management team is satisfied with the integration process so far.
They remain confident in the growth and industry leadership of AAP by continuing a successful
integration of GPI.
Valuation
Summary
After reviewing the outlook of the Auto Parts Stores Industry, comparing the top 3
competitors, and analyzing the company as a whole, I am confident that AAP share prices will
continue to grow as margins are improved. After acquiring General Parts Inc., AAP has become
the largest automotive aftermarket parts provider in North America. The company has
demonstrated tremendous growth in terms of sales as well as store locations, they have
established a company that does not rely on leverage, and they exhibit a sufficient level of free
cash flow relative to the value of the enterprise. However, inferior margins compared to AZO
and ORLY has deterred the growth of AAP’s earnings per share. In order for AAP to improve its
operating margin, their COGS and SG&A expenses need to reach a more suitable level as
demonstrated by its top competitors. Furthermore, continuing to increase sales will counter-act
higher expenses and ultimately improve their margins. A successful integration of General Parts
Inc. is vital to Advance’s success and after year-one of the process, AAP is ahead of schedule.
At the end of Q1 2015, Advance estimates a year-end EPS outlook between a range of $8.10 -
$8.30. With an experienced management team and a company familiar with acquisitions, I am
confident in their future success and recommend AAP as a BUY.
Future Outlook
CFO Mike Norona expresses in AAP’s Q1 2015 report that the company hopes to see
an improvement in operating income to 12% by the end of 2017. AAP’s combined post-
acquisition comparable operating income was 9.1% due to the lower-margin commercial-heavy
business of GPI. However, after one year of operations, the operating income rate improved to
9.9%. Analysts project FY2015 to yield a 10.5% operating margin followed by 11.3% at the end
of 2016. Much of reaching a 12% operating margin for FY2017 relies on delivering the $160M of
synergies previously discussed – Advance is on track to reach these goals with $61M obtained
in year one. In addition to these synergies, optimizing the current supply chain network is
important to improving sales and decreasing COGS. Through expanding hubs and distribution
centers, AAP is closing in on daily delivery for all retail locations. The latest Q1 report claims
700 Advance stores are currently on daily delivery and management expects to reach 1,000
stores by the end of the year (approximately 30%). O’Reilly has provided daily delivery to 85%
of its stores and AutoZone claims to have daily delivery to all of its stores because of its hubs
which are replenished from their distribution centers. With competitors such as AutoZone and
O’Reilly so closely located to Advance, it is very easy to lose customers to a competitor if
certain products are not available at the customers’ request. Management expects the supply
chain systems to be entirely completed by the end of 2017 – at this time all store locations are
expected to be on daily delivery.
COGS and SG&A
Advance expects to see a decrease in COGS and SG&A costs throughout the following
years. Advance has historically demonstrated similar levels of COGS relative to revenue but
their SG&A costs have consistently been higher. After speaking with Advance’s investor
relations, it is difficult to quantify why SG&A costs have traditionally been higher than the
benchmark company ORLY. Investor relations vaguely answered this question and provided no
quantifiable evidence which leads me to believe that the over-arching explanation for lower
margins has been inferior business efficiency. However, investor relations did note three factors
that may have impacted margins. 1) Although it is difficult to find an average rate across all
stores and employees, investor relations claim that Advance pays employees a higher hourly
wage than O’Reilly. IR explains that management has decided to lower wages for store
locations that do not report sufficient sales. 2) Advance has had several outlier stores that have
performed poorly due to location or poor management. Future tasks involve improving these
outliers or closing them altogether. 3) Advance has a relatively new management team that has
not had enough time to improve margins. CEO Darren Jackson joined AAP in 2008, a difficult
year for most companies, and has since closed several acquisitions that may have occupied
time and funds that could have been used to bring down SG&A costs. Nonetheless, recent
acquisitions have been strategic and will ultimately improve business in the long run.
Beginning in 2014, after acquiring GPI, there has been a significant increase in COGS
and a significant decrease in SG&A. At first glance of Advance’s margins, it seems that the
acquisition may have been a poor decision. However, because GPI is a company focused on
low-cost efficiency, Advance’s SG&A percentage decreased by 3.3%, relative to revenue. 2013
year-end SG&A costs were $2.58B and FY2014 SG&A costs were $3.6B. Revenue increased
$3.4B reaching a total revenue of $9.8B. For the first time in the last 15 years, Advance has
SG&A costs similar to that of AutoZone and O’Reilly. Conversely, Advance’s COGS, which
have historically been very similar to that of AZO and ORLY, has gone up. Since the acquisition,
Advance’s COGS, as a percentage of revenue, has gone up 5.5% causing margins to decrease.
FY2013 COGS was 49.9% of revenue ($3.2B), and FY2014 was 54.8% ($5.4B). However, what
many analysts have overlooked is that commercial business has lower margins than DIY. It is
expected for Advance, now a company 60% commercial, to have greater COGS than a
company like AutoZone that is only 20% commercial. Commercial sales involve higher supply
chain costs such as warehouse and distribution expenses, as well as continued investment in
making the supply chain as efficient as possible. It is not surprising to see a significant increase
in COGS after acquiring 38 distribution centers from GPI and significantly more commercial
business. Below is a graph that summarizes GPI’s effect on Advance’s operating margin.
After evolving into a more commercial-based business, it is unrealistic for Advance to
reach an operating margin similar to businesses that are primarily DIY such as AutoZone.
Commercial business requires additional investments and delivery/warehouse expenses which
ultimately yield inferior margins to DIY business. On the other hand, it is very realistic to see
margins near that of O’Reilly’s, a company with a similar business mix. As Advance continues to
invest in supply chain efficiency and integration, SG&A costs will stay low and COGS will come
back to their historic levels similar to ORLY. Supply chain optimization will bring down the
increased warehouse and distribution expenses that came with more commercial business.
Improving DIY
While developing an ideal cost structure is important, continuing the growth of sales is
just as important. Even after a decrease in operating margin from 2013 to 2014, net income still
increased by over 100 million due to an increase of over three billion in sales. Although the DIY
business improved modestly from 2013 to 2014, this segment still needs improvement. The
majority of AAP’s revenue comes from commercial sales but it is still important for the company
to improve their DIY. The improvement of DIY directly relates to the ultimate goal of reaching a
12% operating income by the end of 2017. To achieve this goal, AAP has outlined three
initiatives. Firstly, the Speed Perks Loyalty Program. This newly-added program focuses on
retaining DIY customers who continue to shop at Advance by providing cash rewards upon
store purchases. Customers become a member of the Speed Perks program by signing up
online or at a store location for no fees. A superior aspect of this program compared to the
loyalty program at AutoZone is that all coupons are paperless and stored in Advance’s
computer systems. Members receive a $5 dollar coupon for spending $30 at a store and a $20
dollar coupon for spending $100 at a store. This program focuses on achieving scale through
member acquisition and has been rolled out to all Advance stores. At the end of Q1 2015 there
are already 4 million members and management has set a year-end target of reaching 10
million members. The second initiative towards improving DIY business is an emphasis on
investments and marketing toward DIY customers. Lastly, AAP is continuing to invest in the
store team members. It is important for store employees to be educated in order to ensure that
the customer’s needs are met upon visiting a store location. President of Advance, George
Sherman, explains in the Q1 2015 report that he is satisfied thus far with the progress of the DIY
business.
2015 Q1 Report
When taking a look at the most recent quarter’s performance, a level of uncertainty may
set in for some investors. First quarter performance was lower than expected with comparable
sales increasing by only 0.7%. AAP’s commercial business has been consistently performing at
the high end or above the high end of the market growth range of 3% to 5%. However,
commercial sales this past quarter were at the low end of that range. On the other hand, DIY
sales improved which suggests that some of AAP’s efforts such as the Speed Works program
are working. It was expected that the heavier integration efforts in Q1 2015 would impact
financial performance, but management underestimated the negative effects. The question that
arises after this quarter’s underperformance is whether or not Advance will reacquire the sales
that were lost. Bill Carter, VP of Business Development and Integration, addresses this
uncertainty by explaining that initial impacts of previous acquisitions, such as BWP in 2012,
have been more severe yet still recovered. He assures that they are comfortable about the
recovery and will regain any lost customers in a reasonable time period. Nonetheless, this
quarter marks the sixth quarter in a row for positive comparable sales. Yet due to integration
impacts, Advance has revised their year-end estimated EPS from $8.35-$8.55 to $8.10-$8.30.
Mike Norona, CFO, explains that the comparable sales were partially affected by unfavorable
weather across the Northeast as well as the Great Lakes. Late snow and cold weather hurt DIY
business in these regions which drove down comparable sales as a whole. Although the quarter
report demonstrates low sales and a revised estimated EPS, it is important to reiterate that
year-end synergy estimates remain unchanged at $45 million to $55 million. In the long run, the
success of the integration process will ultimately be more important than individual quarter
sales. Advance is undertaking the largest integration project in the history of the Auto Parts
Stores industry. With that said, it is not surprising that there is some short-term volatility. CEO
Jackson ensures that the volatility will pass and that the long-term potential remains strong.
Peak integration and weather pressures from Q1 have passed leaving Q2 with expected
improving trends.
Earnings and Estimates
AAP currently maintains a price to earnings ratio of 21.29 (6/18/2015). Over the last ten
years, Advance has exhibited a low P/E ratio of 12.41 in FY 2008 and a high P/E ratio of 21.43
in FY 2014, resulting in a range of 9.02. In comparison, over the last ten years, AutoZone
currently holds a P/E ratio of 19.77 with a range of 7.73 while O’Reilly holds a P/E ratio of 29.24
and a range of 16.75 within the same time period. Due to the strong possibility of improved
margins, primarily due to the acquisition of General Parts, AAP’s EPS will improve according to
a consensus of 25 financial analysts. FY 2015 is estimated to generate $8.282 per share, which
is in-line with Advance’s estimate of a range of $8.10-$8.30. The same 25 analysts estimate an
EPS of $9.48 for FY 2016, followed by a consensus of 9 analysts who estimate $10.72 EPS for
2017. Furthermore, these estimates provide a P/E of 18.72 by 2015 year-end, followed by 16.33
for FY2016, and 14.46 for FY2017.
Dividends and Buybacks
On February 11, 2015, Advance’s Board of Directors declared a quarterly dividend of
$0.06 per share to be paid on April 3, 2015 to all common stockholders of record as of March
20, 2015. Since 2008, Advance has paid annual dividends of $0.24 per share. Additionally,
Advance authorized a program in May 2012 that allows up to $500M of common stock to be
repurchased. The company did not repurchase any shares under this program; however, other
repurchases were made in Q4 2014 and Q1 2015. Advance repurchased 27,996 shares of
common stock at an aggregate cost of $4.3M and at an average share price of $154.14 in Q4
2014 and $1.6M worth of shares in Q1 2015. Mike Norona states in the 2015 Q1 report that
once enough debt is paid down to maintain suitable investment grade ratings (BBB-, Stable),
the share buyback program will be deployed which should help drive shareholder value. AAP
Investor Relations approximate the program to commence late 2015 or sometime throughout
2016.
Conclusion
Advance Auto Parts, Inc. has projected an operating margin of 12% by the end of 2017
as well as an estimated $160M worth of synergies over the three years post-acquisition.
Although the integration process disrupted estimates in Q1 of 2015, AAP’s management has
Consensus
Estimate Actual
2010 $3.95 $3.95
2011 $4.99 $5.11
2012 $5.10 $5.22
2013 $5.49 $5.67
2014 $7.68 $7.59
2015 $8.25 n/a
2016 $9.48 n/a
2017 $10.72 n/a
2018 $13.17 n/a
2019 $15.64 n/a
EPS Adjusted
confirmed that the progress of attaining the desired 12% margin is on track, and that the
synergies are ahead of schedule. FY2015 is expected to have a 10.5% operating margin and
synergies in the range of $45M to $55M should be obtained. SG&A costs will continue to fall
and COGS will come back to traditional levels when the supply chain is optimized. Through
expansion, Advance has become the largest automotive aftermarket parts provider in North
America and has become available to a large client base throughout the continent. The largest
acquisition in the industry’s history has positioned AAP to have years of growth, improved
margins, and earnings. A consensus of 12 analysts gives AAP a year-end target price of
$172.50, an increase of 8.04% from a current price of $159.67 (6/17/2015, 4p.m.). For these
reasons, Advance is a BUY.
