It's been a difficult ride for investors of Advance Auto Parts (AAP 0.58%). The stock is down 56% in the last five years, compared to a 54% gain for the S&P 500 index. And it has tanked 53% just this year. It's likely an understatement to say that there's a ton of pessimism surrounding this business.
It's no wonder that, as of this writing, shares of Advance Auto Parts trade at a trailing-price-to-earnings (P/E) ratio of 10.3. That might be compelling for investors looking for deep value stocks. But I think it's best to avoid the company altogether.
Here's why.
A struggling business
Advance Auto Parts has been such a huge disappointment for investors because of its terrible financial performance. Between fiscal 2017 and fiscal 2022, revenue increased at a compound annual rate of just 3.6%. And same-store sales, one of the most important metrics to gauge the health of a retail enterprise, actually declined 0.4% during the first quarter of fiscal 2023, which is not a good sign. Profitability is also unimpressive, as the operating margin was 2.6% in Q1.
The leadership team, led by CEO Tom Greco, continues to stay focused on bolstering the underlying business. "We remain committed to executing against our key initiatives to drive top-line growth and improve operational performance," he said on the Q1 2023 earnings call. Key to this so-called transformation is to drive greater sales with professional customers, while improving pricing and parts availability.
Probably the single most important factor working against Advance Auto Parts is management's poor job at successfully managing inventory and turning it into cash. Having the right parts on the shelves is critical because consumers are in a time crunch, needing the right tools and supplies to fix their cars and get back on the road. Without the correct mix of inventory, customers will go elsewhere.
This means Advance Auto Parts isn't doing a good job at converting the cash it spends on the inventory into cash received as revenue, called the cash conversion cycle. In the last fiscal year, the cash cycle was 79 days. In comparison, massive retailer Walmart takes just six days.
Rivals do it better
The company's fundamentals are shockingly bad in their own right, but even more so when looking at two thriving industry rivals, O'Reilly Automotive (ORLY -0.97%) and AutoZone (AZO 0.03%). Their revenue growth has been much stronger, with greater profitability. In their last fiscal quarters, both O'Reilly and AutoZone posted operating margins of 21%.
Moreover, both companies have cash conversion cycles in negative territory, meaning that they are able to sell inventory to customers before having to pay their suppliers for the goods. Since it essentially runs the same business model, it's alarming that Advance Auto Parts can't slowly approach its competitors when it comes to this data point, an obvious sign of mismanagement.
While Advance Auto Parts had to recently cut its dividend to "enhance financial flexibility," O'Reilly and AutoZone are too busy generating copious amounts of free cash flow that is consistently used to do stock buybacks. An outstanding share count that gets steadily reduced provides a significant boost to earnings per share.
These impressive metrics clearly demonstrate that O'Reilly and AutoZone are far superior businesses when compared to Advance Auto Parts. And that's what matters to the share price over the long term. In fact, both of these rivals have seen their stocks absolutely crush the S&P 500 in the last three-, five-, and 10-year periods.
Consequently, both of these stocks trade at much higher P/E multiples than Advance Auto Parts today. But based on their strong fundamentals, investors who are looking to allocate capital to this industry will be much better off investing that money into shares of O'Reilly and AutoZone instead.
