There's something wrong with auto-parts retailer Advance Auto Parts (AAP 4.25%), and the stock is worth avoiding until the company fixes its course. In this article, I'm going to highlight a few charts that date back to when an activist hedge fund, Starboard Value, unveiled a stake in the company (Sept. 2015) and further discuss the key metrics to watch for this company.
The original case for buying Advance Auto Parts
It was a classic value investment argument back in 2015, and it's arguably the same case now. The idea is Advance's operational metrics so clearly lag its nearest peers, O'Reilly Automotive (ORLY 0.57%) and AutoZone (AZO 1.19%), that all the company needs to do is improve its operations to something resembling its rivals to generate significant value for investors.
Advance Auto Parts continues to lag its peers
Unfortunately, the tale told in the the price chart below shows the company is still very far from achieving its aim.
Data by YCharts.
It's not hard to see why. Advance Auto Parts' profit margins and free-cash-flow generation (shown here as a percentage of its assets) are nowhere near its peers.
Data by YCharts.
How Starboard planned to improve operational performance
To be clear, Starboard has now exited its position in the auto-parts retailer. And it's hard to argue the activist firm's input (Starboard CEO Jeffrey Smith served on the Advance Auto Parts board from 2015 to 2020) had actually improved the company's results.
When Starboard initially got involved, there were high hopes the auto-parts retailer's profitability and cash flows would improve, driven by a reshaping of the supply chain, distribution, and inventory management. In a nutshell, Starboard wanted Advance to get more products to its stores quicker so customers, particularly professionals serving the do-it-for-me market, would become regular, loyal shoppers.
At the same time, Starboard wanted Advance Auto to improve its working capital requirements by increasing its accounts payable-to-inventory ratio. This is simply a ratio of the money owed to suppliers (higher accounts payable means more cash retained by Advance Auto) to inventory (higher inventory implies cash tied up in merchandise). As such, a higher accounts payable-to-inventory number is often desirable.
What happened
Unfortunately, Advance Auto remains significantly behind the curve.
Here's the accounts payable-to-inventory ratio among the three major auto-parts retail chains where you can see how Auto is the laggard the group.
Data by YCharts.
And it gets worse. Here's a look at the receivables turnover ratio. This measures sales divided by average accounts receivable. So, the higher the number, the better the company is at collecting receivables on its sales. It's not an area that Advance Auto excels in.
Data by YCharts.
Finally, here's a look at the days' inventory outstanding (the average number of days a company holds inventory before selling it, so the lower this number the better). Here again, Advance Auto hasn't notably improved its performance going back to late 2015.
Data by YCharts.
What's next for Advance Auto Parts?
With lagging metrics like these, it's no surprise the company's latest earnings report once again saw it fall behind O'Reilly and AutoZone. Meanwhile, seven years on from Starboard's initial involvement, Advance Auto's CFO Jeff Shepherd said on the earnings release that "getting more parts closer to our customers is a top priority" and promised "strategic inventory investments to improve our availability" while noting that "inventory is the primary driver of our reduced free cash flow guidance."
It's a familiar playbook, but until Advance Auto starts demonstrating significant improvement in its inventory management, receivables collections, or management of accounts payable, as discussed above, these ongoing red flags make it hard for investors to feel confident buying the stock.
