If you've read Peter Lynch's books, you've heard of Pep Boys (NYSE: PBY). If you haven't read Peter Lynch's books, finish reading my column here and then go to your nearest library or bookstore and get them. Though once a great stock for this investing master, it looks to this Fool like Pep Boys is trying to force together ill-fitting parts to the detriment of its owners.
Although the stock is up early this Friday morning, I'm not that thrilled with what I saw in the earnings release. Sales were down 2.4%, with merchandise down 0.6% on a comparable basis and service revenue down 8.2% on a comparable basis. While profits from merchandise sales held up OK, margins in the service business took another beating. At the operating line, a year-ago profit was reversed to a loss, and ditto at the net income line.
Year-to-date cash flow performance is also sputtering, producing that nifty bluish smoke. Though it wasn't like Pep Boys produced much operating cash flow last year, at least it was positive -- something no longer true of this year.
To me, there is two-pronged trouble here. First, the company competes in a crowded market with Advance Auto Parts (NYSE: AAP), Motley Fool Inside Value pick AutoZone (NYSE: AZO), and O'Reilly (Nasdaq: ORLY), to say nothing of the dozens of privately owned shops that cater to gearheads. Although the company is trying to refurbish its stores to boost same-store sales, poor operating performance is leading the company to stretch out this process to conserve resources.
Second, the company continues to pursue what I think is a doomed service aspect of the business. Not only are the margins here substandard, but they've been dragging down the company's overall margins for some time now. What's more, the recent compound growth rate in service revenue has been on the order of negative 2%.
Now, I realize it takes time for some concepts to work themselves out, but I think it's high time that Pep Boys pull the plug here. It seems to be a drain on resources, and it might even be an irritant to potential commercial customers in the service business.
Unfortunately, management still seems to want to cure, not euthanize, the service business. As long as that's the case, I'd stay away. Investors should note, though, that the company owns about half of its stores and likely has a scrap value somewhere around $10 to $12 a share. At a discount to that price, I might be more interested.
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Fool contributor Stephen Simpson has no financial interest in any stocks mentioned (that means he's neither long nor short the shares).
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