What happened
Shares in auto parts retailer Advance Auto Parts (AAP 0.58%) fell 18.7% in September, according to data provided by S&P Global Market Intelligence. There are two reasons for the fall. First, in September, S & P Global Ratings cut the company's debt rating to "junk" status. Second, one of its major rivals, AutoZone (AZO 0.03%), gave earnings that could be construed negatively for Advance Auto Parts.
The credit rating downgrade included criticism of Advance's "misguided" approach of holding pricing to maintain profit margin. It's an action seen as leading to market share erosion and, ultimately, weak sales growth. In addition, it didn't do much for Advance's consistently poor margin performance anyway.
Turning to the connection to AutoZone's earnings, it's somewhat nuanced, so bear with me. Going back to Advance's second-quarter earnings (which ended in mid-July), management lauded the slight improvement in sales it had seen in the last four weeks of the quarter (mid-June to mid-July), which led to low-single-digit year-over-year (YOY) growth in the first four weeks of the third quarter (mid-July to mid-August).
This was put down to the initiatives such as "inventory investments we made along with year-to-date improvements in supply chain fill rates and store on-hand rates," according to Advance's outgoing CEO Tom Greco on the earnings call.
However, fast-forward to AutoZone's fourth-quarter earnings report (which ends on Aug. 26), and AutoZone's management also talked about a slower first half of the quarter (sales were flat on the same period in 2022) to a 3.4% YOY improvement in the second half of the quarter (end of July to end of August). Given that this period largely coincides with the period when Advance generated low-single-digit growth, it suggests that Advance's improvement came down to an improved market backdrop driven by more extreme weather -- cars need servicing more in extreme heat or cold -- rather than initiatives taken by Advance's management.
Image source: Getty Images.
So what
Advance has serially underperformed its two major rivals, AutoZone and O'Reilly Automotive, over the years, and new CEO Shane O'Kelly has his work cut out if he wants to improve matters, particularly if Advance wants to get anywhere near the kind of 20% operating margins and cash flow generation enjoyed by its peers.
According to Interim Executive Chair Gene Lee on the last earnings call, Advance should "start seeing incremental improvement, pretty quickly here," and he doesn't see Advance's improvement strategy taking "less than one year."
Now what
Suppose S & P Global Ratings' criticism is correct, and the sales improvement turns out to be merely the result of an improving sales environment rather than anything to do with investments made by Advance. In that case, it looks likely that a comprehensive review of the business needs to be made. Cautious investors will want to wait for that before buying in.
