2 Aftermarket Retailers Worth Watching

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Pep Boys-Manny, Moe & Jack (UNKNOWN: PBY.DL  ) is an aftermarket retailer whose business model is different from the likes of O'Reilly Automotive (NASDAQ: ORLY  ) and Advance Auto Parts (NYSE: AAP  ) . Pep Boys' business model is a profitable mix of do-it-for-me services and tire offerings with a do-it-yourself parts and accessories business. A major chunk of about 80% of its revenue is derived from the services and tires segment.

All three companies have had a good run up in the last three years, which is quite understandable as the average age of cars in the U.S has grown to all-time highs at 11.4 years.

PBY Chart

Pep Boys data by YCharts

Market potential
The average age of vehicles in the U.S has hit an all time high of 11.4 years as mentioned earlier, up from 11.2 and 10.9 in 2012 and 2010, respectively. This shows that Americans are holding onto their vehicles longer than before despite an increase in new car sales. The percentage of vehicles older than 12 years of age has increased by 20% and this is one of few tailwinds for companies like Pep Boys.

As the average age of vehicles on the road increases, the size of the automotive- aftermarket industry is bound to grow as well. According to estimates from the Automotive Aftermarket Industry Association and the Automotive Aftermarket Suppliers Association, the U.S. auto-aftermarket industry is estimated to grow at a rate of 3.4% annually through 2016 to $263.8 billion, adding $32.6 billion to the economy.

Another tailwind is the buoyant mood that the automobile sector is in today after the recession. The trend in auto sales during the period after the recession has been on an uptrend.

US Auto Sales Chart

US auto sales data by YCharts

The automotive-service industry is approximately four times the spare parts, or DIY, market. After the recent economic downturn, as the economy is in recovery mode, the focus is again shifting from DIY to DIFM. This general fall in the DIY segment might continue as vehicles are getting more complex with every new model.

This trend is also visible in the chart below that shows DIY share by difficulty of repair. We see that there's a general declining trend in DIY across the board and this is a tailwind for companies in this segment of the automotive-aftermarket industry. Auto repair shops perform an estimated 70% of repairs for out-of-warranty vehicles, according to the Automotive Service Association.

 Looking ahead
To serve the growing DIFM market, Pep Boys is introducing new designs for its stores. Through these news store designs, the company aims to make servicing and engagement with customers more intuitive and seamless. The new design of the stores is also aimed at making the same appealing to women who prefer a nicer atmosphere when it comes to bringing their vehicles in for service and repairs. As of 2010, more than 105.7 million women were licensed to drive in the U.S. compared to 104.3 million men. This gender shift is continuing.

The company expects the new store designs to eventually generate around $1 million in sales each and produce around $150,000 in earnings before interest, taxes, depreciation, and amortization per year.

Inline with its business model, the company purchased 17 Discount Tire Centers from AKH Company. All of the centers are in the greater Los Angeles market. As a result of this acquisition, at least one Pep Boys location will now be within a three-mile radius of almost three-fourths of Los Angeles' population.

Looking around
On the back of a buoyant performance of the automobile industry and ageing vehicles on American roads, O'Reilly Automotive reported strong results in the second quarter, where it delivered a 37% increase in earnings.

Looking ahead, O'Reilly is aggressively expanding its footprint and that's why it had acquired VIP Parts, Tires & Service's parts business last year. The acquisition added 56 new stores to its footprint in Maine, New Hampshire, and Massachusetts. The company also opened 10 stores in California in the last quarter apart from a distribution center in Chicago.

These moves should help O'Reilly to improve its business further going forward and compete against the likes of Advance Auto Parts, which is also growing aggressively. Advance Auto has been on an aggressive expansion drive and celebrated the opening of its 4,000th store last month.

Advance Auto is also focused on improving its commercial business, which it estimates to be worth $40 billion. Its acquisition of BWP Distributors early in 2013 expanded its footprint by 124 stores and the company has also been beefing up its sales team to generate higher sales.

The bottom line
Given the strong performance of the aftermarket-retail industry despite rising sales of new cars, the performance of these three companies so far is commendable. All three have been making strategic moves to capture more market share and as such, investors should take a closer look at them.

O'Reilly and Pep Boys, however, look like better bets since their earnings are expected to grow at a compound annual growth rate of 17.3% and 14%, respectively. In comparison, Advance Auto's expected growth rate is just 10%, which makes it slightly less attractive as compared to the other two companies.

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9/30/2016 4:02 PM
AAP $149.12 Up +2.38 +1.62%
Advance Auto Parts CAPS Rating: ***
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PBY.DL $0.00 Down +0.00 +0.00%
The Pep Boys CAPS Rating: **