Is the Largest Auto-Parts Retailer a Good Buy?

The U.S. auto-parts industry is enjoying several tailwinds -- brutally cold weather, the complex nature of modern vehicles, and a record high average age of vehicles on U.S. roads. These are compelling reasons why Advance Auto Parts (NYSE: AAP  ) , O'Reilly Automotive (NASDAQ: ORLY  ) , and AutoZone (NYSE: AZO  ) have beaten the broader market in the last year.

Looking ahead, it is expected that these factors will continue favoring aftermarket retailers, which are aggressively expanding their network by opening new stores or by making acquisitions. Among them, Advance Auto Parts is leading the charge and has become the largest auto-parts retailer in North America.

Why size matters
With more than 5,400 stores in operation, Advance Auto Parts will be able to cast a net that's wide enough to benefit from the growth of the aftermarket retail industry. The number of aging vehicles on the roads is growing, despite new-vehicle sales on the rise, and this trend could continue.

According to Polk, the average age of vehicles on U.S. roads had an all-time high of 11.4 years last year. This average is expected to climb as vehicles become more reliable, which is why owners can keep them longer if they perform routine maintenance. Polk expects the count of vehicles above 12 years to grow by more than 20% by 2018, and this is where Advance Auto's expanding network can help it land more business. 

Additionally, Stifel Nicolaus analyst David Schick projects that severe weather conditions seen in the U.S. could lead to higher demand for auto parts. The rate of failure for certain parts increases due to cold weather, and this is another trend on which Advance Auto Parts should capitalize due to its wide reach.

Advance Auto is quite optimistic about its General Parts acquisition. Management believes that the deal will help Advance Auto focus on both the commercial and do-it-yourself, or DIY, businesses as it will be able to reach a broader customer base.  

Focus on quality
More importantly, Advance Auto is focused on becoming the best auto-parts retailer. The company is concentrating on strengthening its inventory and replenishing some of its stores daily. Daily replenishment is leading to better performance with better sales, which is why Advance Auto Parts will continue to evaluate opportunities to expand this program. 

In addition, Advance Auto is consistently increasing its hub count. The company has 374 hub stores in operation, enabling it to better serve its stores by restocking inventory more efficiently.  Moreover, Advance Auto's initiatives seem to be bearing fruit since its recently opened stores are outperforming previous new store openings. 

Going forward, Advance Auto expects this momentum will continue as it integrates its General Parts acquisition. According to management, this acquisition was the next logical step for Advance Auto Parts as it is highly focused on growing its commercial business, which is growing twice as fast as its DIY segment. The opportunity in commercial is as large as $40 billion, so it is easy to see why Advance Auto is aggressively pursuing this market.  

An eye on the competition
However, Advance Auto can expect stiff competition from the likes of O'Reilly and AutoZone. O'Reilly is strengthening its presence in markets where it doesn't have coverage. The company is deploying commercial programs in the Western U.S. and the Northeast. In addition, O'Reilly is also looking to improve its supply chain by opening more distribution centers. O'Reilly could pose a serious challenge to Advance Auto's DIY business through its loyalty program that has seen 4 million member sign ups in a relatively short period. 

AutoZone, the second-largest aftermarket retailer, still hasn't rolled out the commercial program to all of its stores. At present, AutoZone runs a commercial program in around 3,600 stores out of a total of 5,200 stores. John Lawrence, an analyst at independent financial services firm Stevens, is of the opinion that AutoZone can ramp up its commercial program to all of its stores within a few months if needed. Since AutoZone is close behind Advance Auto Parts in terms of store count, it could become a big threat once the company's commercial business expands.

The bottom line
But despite all this competition, you can't deny that Advance Auto Parts size is a big advantage. There is enough room for all players to co-exist in this industry, but Advance Auto's moves suggest that it is trying to capture as much of the market as possible. It has made some important acquisitions -- including the BWP acquisition last year -- and is improving the quality of its stores by bolstering its supply chain.

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