Monro Muffler Brake: A Few Clangs and a Shimmy

Next to Monro Muffler Brake (Nasdaq: MNRO  ) , maybe Pep Boys' (NYSE: PBY  ) performance doesn't look so bad. That might be the convenient conclusion, but I don't think it's the right one, since I think Monro has fewer structural performance issues than Pep Boys, which is currently searching for a new permanent CEO.

About the only way Monro's quarter looks good is if you were expecting it to be even worse. Sales were up 4% as reported, but same-store sales were down nearly 3%, as weakness in the exhaust and shock categories offset a decent performance in general maintenance and a better performance in tires.

Since Monro is partly a story about operating leverage, less-than-stellar top-line results led to more pain further down the income statement. Gross margins compressed as the revenue mix migrated to the lower-margin tire and maintenance business, and operating income dropped 17%. And even future guidance wasn't all that rosy. Looking for maybe 2% growth in comps next quarter is better than this quarter's result, but it's not exactly high-level performance, either.

So how is it that I have anything nice to say about Monro? Well, for starters, I see the company as a credible name in a fragmented market. Apart from Midas (NYSE: MDS  ) , Pep Boys, and privately held Meineke, there are few competitors with name-brand recognition beyond the regional level.

Second, what's bad for Ford (NYSE: F  ) and General Motors (NYSE: GM  ) may prove to be good for Monro -- fewer new cars mean more old cars on the road. Moreover, there was a little jump in new auto sales back around the turn of the century, and some of those warranties should be rolling off right about now.

I think it's also important to point out that Monro has been generating returns on capital that are both generally improving and approaching the cost of capital. Not so for Midas or Pep Boys, reinforcing my hunch that Monro's management may have a better plan in place.

There's plenty of opportunity for Monro to grow, and there's also ample opportunity to better leverage the infrastructure for stronger margins and returns. Even allowing for differences in the underlying business, I think Monro can get closer to the returns on capital seen at parts sellers AutoZone (NYSE: AZO  ) and Advance Auto (NYSE: AAP  ) . In the meantime, valuation makes this a "look but don't touch" stock for me -- I'm willing to give the company the benefit of the doubt on growth in the coming years, but I still want my double-digit discount to fair value before buying.

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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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