The stock of automotive aftermarket-parts retailer Advance Auto Parts (AAP 0.58%) is down 64.5% over the last year, in contrast to its peers O'Reilly Automotive (ORLY -0.97%) and AutoZone (AZO 0.03%), which are up 42.7% and 16.4%, respectively. This is not a story of an industry in trouble, but rather one about the underperformance of a company within the sector and how retail investors could see the warning signs.
Where did it all go wrong?
In 2015, highly respected activist investor Starboard Value thought it had identified a value opportunity in Advance Auto Parts that would see the stock price rise from $171 to $350. At the time of this writing, the company's stock is nearer $68.
Starboard's case was powerful and relied on a well-known value-based approach. Advance's margins and sales growth significantly lagged behind its two prominent peers, AutoZone and O'Reilly Automotive, and there was an opportunity to close the gap.
Moreover, Advance's exposure to the faster-growing do-it-for-me (DIFM) market meant it had a natural growth opportunity.
Improving inventory management
In improving its business to the level of its peers, Advance would generate significant value for investors and satisfy its customers by enhancing its inventory and supply chain management.
This is a crucial issue in the industry, as consumers -- and professionals in particular -- often require a part immediately. Better inventory management would reduce days of inventory outstanding -- that is, the number of days a company holds its inventory before selling it. It would also improve Advance's position in the DIFM market, leading to higher growth and margin expansion.
The chart below shows how many days on average it takes each company to clear its inventory, so a lower number is better. Unfortunately, Advance's management failed to reduce it significantly over the years, and it's still far higher than its rivals' numbers.
Data by YCharts.
Improving accounts payable
At the same time, Advance would improve its working capital usage (the money tied up in the business) by increasing its accounts payable over inventory ratio -- meaning taking relatively longer to pay its suppliers for inventory. A higher number is better because it implies Advance would hold on to cash relatively longer. Improving the ratio would free up valuable cash to use elsewhere in business operations.
It didn't happen. Or at least it didn't reach anything near the standards of its peers, and Advance continues to be the laggard.
Data by YCharts.
Lowering the receivables turnover ratio
More working capital improvements were supposed to come by lowering its receivables turnover ratio, meaning Advance Auto Parts would do a better job of collecting receivables from its customers; in other words, collecting money from sales made to clients. Again, this would generate relatively more cash up front, which could be used to run the business better -- say, in making more products more readily available, particularly for the DIFM market.
Again, it didn't happen.
Data by YCharts. TTM = trailing 12 months.
And, of course, Advance's operating margin consistently lagged its peers. In the end, Starboard exited its position in May 2021.
It's a move that proved prescient as Advance's stock is down a whopping 67% since the start of May 2021. Over the same period, O'Reilly's stock is up 60%, and AutoZone is up 59%. This is an Advance Auto Parts problem, not an industry one.
Data by YCharts.
What it means to investors
The point of looking at these metrics is to highlight that these were precisely the metrics Starboard hoped would improve and those that the company's progress would be judged on. And those issues existed even when the stock price was closer to $240 (in early 2022) than the $68 it currently trades on. The warning signs were there.
All of this is not to be too negative on the prospects for the company because there's still a value opportunity. CEO Tom Greco is retiring at the end of the year, and whoever replaces him will undoubtedly have the plan to turn these metrics around. But until there's tangible proof of improvement on the metrics discussed above, then the stock is unattractive.
There is a value case to be made for the stock, but based on the above, it's not a strong one for long-term investors until management can provide hard evidence of improving the metrics above. The good news is that these numbers can be ascertained by retail investors using publicly available information.
