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This Sleepy Sector Is Going Gangbusters, and No One's Talking About It

By Jeremy Bowman - Oct 19, 2020 at 8:56AM

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This group of recession-proof stocks trades at a discount to the S&P 500 and is seeing profit growth of 30% or more.

Most investors have heard of the hot coronavirus stocks by now.

"Stay-at-home" favorites like Zoom Video Communications and Peloton Interactive have skyrocketed this year on the back of triple-digit revenue growth. Tech stocks similarly have crushed the market, especially in cloud computing and e-commerce. Even the mighty FAANG group has seen mouthwatering gains, pushing Apple to a $2 trillion market cap and Amazon past $1.6 trillion. Electric-vehicle stocks, led by Tesla, have also boomed.

However, the recovery may have already shifted gears. Stocks peaked more than six weeks ago, and concerns about a fading recovery in the job market and jitters around the election could rattle the market even further. Investors may want to look beyond the high-profile tech names to sectors that have been mostly ignored thus far, and one area that seems ready to take off is auto parts. Though the sector typically outperforms during a recession, the top auto parts stocks have only delivered average returns this year, essentially tracking with the S&P 500

AAP Chart

Data by YCharts.

As you can see, Advance Auto Parts ( AAP -0.83% )O'Reilly Automotive ( ORLY 0.28% ), and AutoZone ( AZO -0.28% ) are actually all trailing the broad-market index slightly, but these companies have already begun to experience robust recoveries from the depths of the crisis.

AAP Revenue (Quarterly YoY Growth) Chart

Data by YCharts.

Revenue has bounced back, and all three of these companies saw profits jump by more than 30% in their most recent quarters with Advance and O'Reilly seeing gains in the 50% range. Better yet, there are a number of signs that their performance will only accelerate from here.

Auto-parts retailers tend to thrive during recessions and their aftermath, because they sell products consumers need, not just what they want. Most Americans need a vehicle to get to work or take care of regular errands, and especially during economic downturns, Americans tend to delay buying a new vehicle and instead focus on maintenance and repairs, which means trips to the auto-parts store.

However, this recession, brought about by a once-in-a-century pandemic, is also unique as it has spurred demand for personal vehicles as Americans look to avoid public transportation and ride-sharing services for safety reasons.

A man holding a container of motor oil inside a store

Image source: Getty Images.

Grab the wheel

Auto sales as a whole have jumped during the pandemic. According to the Census Bureau, sales of auto vehicles and parts surged 10.9% in September and 7.5% in the third quarter. The used car market has been the biggest driver of that growth.

Used car dealers like Carvana and Vroom have been unable to keep up with demand, and both companies have reported rising prices for used cars. Edmunds.com reported that August and September were the fastest months for used car inventory turnover in six years.

Those trends are likely to remain strong as a vaccine is at least months away, and the need for personal vehicles isn't changing. Many of the auto-parts companies are seeing similar trends.

AutoZone, which was the most recent of the group to report earnings, posted domestic comparable-sales growth of 21.8% in its fiscal fourth quarter (ended Aug. 29). Adjusted earnings per share were also up 47.6% year over year. CEO William Rhodes sounded bullish about the coming months on the earnings call, saying: "And if the economy enters a deep and protracted recessionary environment, we continue to believe our customers will focus more on maintaining their current vehicles, and it will benefit our business -- retail in particular -- as it has in the last three recessions." From fiscal 2009 to fiscal 2011, same-store sales growth averaged 5.4%. Rhodes also noted that August comps, which came after enhanced unemployment payments ended, showed strong growth at 16.5%, and he speculated that sales would remain elevated "for some time."

During the second quarter, when the global economy was cratering, O'Reilly's comparable sales rose 16.2%, and earnings per share jumped 57%. Management at O'Reilly and Advance echoed Rhodes' comments.

The price is right

Considering these stocks are seeing double-digit comparable-sales growth that's flowing to the bottom line, they look downright cheap. In fact, all three trade at a discount to the S&P 500 based on their price-to-earnings ratios: 23.8 for Advance, 22.9 for O'Reilly, and 16.6 for AutoZone. Meanwhile, the S&P 500 currently has a multiple of 35, which is elevated due to the decline in earnings during the first half of 2020.

Analyst estimates have been moving higher for the sector, but they still seem to be underestimating the tailwind of the pandemic and economic downturn. At AutoZone, for example, the consensus estimate is for just 4% earnings-per-share growth for the fiscal year that just started. Analysts expect to see a 21% gain at O'Reilly this year, but that figure declines to just 2% in 2021. And Advance is actually forecast to see flat earnings growth this year.

Keep in mind that these companies usually experience a surge in demand during a typical recession, and the additional impact of the pandemic means that they are likely to put up record growth during this time, as we saw in their most recent reports, all of which crushed estimates. The numbers from the Census Bureau also show that momentum in the auto sector accelerated in September, boding well for the parts sellers.

If these companies outperform once again in their upcoming reports, the stocks should take off.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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Stocks Mentioned

AutoZone, Inc. Stock Quote
AutoZone, Inc.
AZO
$1,863.00 (-0.28%) $-5.29
O'Reilly Automotive, Inc. Stock Quote
O'Reilly Automotive, Inc.
ORLY
$659.18 (0.28%) $1.83
Advance Auto Parts, Inc. Stock Quote
Advance Auto Parts, Inc.
AAP
$226.86 (-0.83%) $-1.90
Apple Inc. Stock Quote
Apple Inc.
AAPL
$161.84 (-1.17%) $-1.92
Tesla, Inc. Stock Quote
Tesla, Inc.
TSLA
$1,014.97 (-6.42%) $-69.63
Amazon.com, Inc. Stock Quote
Amazon.com, Inc.
AMZN
$3,389.79 (-1.38%) $-47.57
Carvana Stock Quote
Carvana
CVNA
$261.35 (-1.62%) $-4.30
Zoom Video Communications Stock Quote
Zoom Video Communications
ZM
$183.92 (-4.08%) $-7.83
Peloton Interactive, Inc. Stock Quote
Peloton Interactive, Inc.
PTON
$43.55 (-2.02%) $0.90
Vroom, Inc. Stock Quote
Vroom, Inc.
VRM
$12.65 (-6.78%) $0.92

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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