This Auto-Parts Retailer Might Be a Good Investment

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Auto-parts retailer Advance Auto Parts (NYSE: AAP  ) hasn't been the best performer in its industry this year. Its gain of just under 12% is dwarfed by peer O'Reilly Automotive's (NASDAQ: ORLY  ) 42% appreciation. However, the more conservative investor should give Advance Auto a thought because it's valued cheaply and has been gradually turning its business around.

At 15 times earnings, Advance Auto is considerably cheaper than O'Reilly, which has a trailing P/E of 23. Also, Advance Auto's same-store sale growth has been improving. In the second quarter, same-store sales declined 0.30%, which is a marked improvement over the year-ago quarter's decline of 2.70%. However, Advance Auto management expects comps to be "slightly down" this fiscal year. 

Tailwinds to consider
But given the trends in the auto industry and Advance Auto's expansion plans, the company's performance over the long run might improve further. With the average age of vehicles on American roads now at an all-time high of 11.4 years and 70% of those being over seven years old, Advance Auto believes that there is opportunity going forward. 

Management stated that Advance Auto's weak same-store performance was partly due to higher payroll taxes and high unemployment, as these factors hurt its sales in the do-it-yourself segment. However, these are the factors that might lead vehicle owners to stretch their dollars and keep their older vehicles running.

Opportunity in commercial
So, there might be some reprieve for Advance Auto in the do-it-yourself segment going forward as deferred maintenance of vehicles remains at elevated levels. In addition, the company is focused on strengthening its commercial segment. Advance Auto believes that the commercial market is worth $40 billion at present and is growing at twice the rate of the do-it-yourself segment. 

As such, Advance Auto is strengthening its capabilities to serve commercial customers. It has been improving the availability of parts and bolstering its sales force to tap this market. To complement its moves in the commercial market, Advance Auto had acquired 124 stores of BWP Distributors earlier this year. This acquisition has helped Advance strengthen its presence in the Northeast. 

Advance Auto is also following an aggressive store expansion program and added 21 new stores in the previous quarter. The company remains on track to open 170 to 190 new stores this fiscal year. Importantly, the stores opened in fiscal 2012 and 2013 have exceeded management's expectations as the commercial business has been ramping up. 

All these developments can lead to a better performance in the future as Advance Auto's commercial sales increase further. In addition, the do-it-yourself segment is also expected to gradually pick up on the back of more store openings and supply chain investments. Given these expected improvements and the reasonable valuation, Advance Auto looks like a good pick for conservative investors over the long run.

But investors should keep a close watch on the progress of the commercial program as Advance Auto could face competition from AutoZone (NYSE: AZO  ) in this market. AutoZone, the largest auto-parts retailer in the U.S., runs a commercial program in 68% of its stores -- a substantial number considering it operates around 5,100 stores, while Advance Auto opened its 4,000th store recently.  

In addition, AutoZone plans to open 300 stores in the current fiscal year as it looks to increase its lead further over peers. 

Considering O'Reilly
For those who are looking for a more aggressive play in the auto-parts industry and are unfazed by a rich valuation, O'Reilly might prove to be a good pick. O'Reilly's comp growth has been phenomenal of late. Same-store sales had jumped 6.5% in the previous quarter, way better than the 2.5% in the year-ago period and ahead of its own estimate of 4% to 6%.

O'Reilly has also been expanding its network and had acquired 56 stores of VIP Parts, Tires & Service last year. In addition, the company is rolling out a loyalty program that proved to be a success in the pilot phase and believes that this program will help it capture more do-it-yourself customers. As mentioned earlier, the company trades at 23 times earnings, but the multiple comes down to a more reasonable 18.6 on a forward basis.

The bottom line
Advance Auto is not a stock that will appreciate rapidly; however, it can provide stability to a portfolio. An increase in the average age of vehicles and consumers remaining under pressure due to reasons stated above should lead to more spending on repairs and maintenance going forward, while growth in the commercial market is another tailwind for the company.

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Related Tickers

9/30/2016 4:02 PM
AAP $149.12 Up +2.38 +1.62%
Advance Auto Parts CAPS Rating: ***
AZO $768.34 Up +2.58 +0.34%
AutoZone CAPS Rating: ***
ORLY $280.11 Up +1.21 +0.43%
O'Reilly Automotiv… CAPS Rating: ****