It is always a troubling sign when a company cuts its dividend. Sometimes there's a good reason for a dividend cut (like a spin off), other times it is simply an indication of business difficulties that are expected to linger for longer. The second situation is what appears to be the case at Advance Auto Parts (AAP 0.58%) right now.
Here's a quick examination of the events taking shape and how investors should be thinking about the stock today.
Its dividend cut got the ball rolling
In the company's fiscal first quarter, Advance Auto Parts declared a dividend of $1.50 per share. In the fiscal second quarter that dividend was dropped to $0.25, which is slightly more than 80% lower. As far as dividend cuts go, that was a pretty big reduction. Perhaps not surprisingly, it came along with a weak earnings release.
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Notably, Tom Greco, the auto parts retailer's CEO at the time, noted that "while we anticipated the first quarter would be challenging, our results were below our expectations." Same-store sales were down, gross profit margin declined, and SG&A expenses were higher. Year over year, fiscal first-quarter earnings fell from $2.28 per share to just $0.72. The company drastically reduced its full-year guidance, with the earnings outlook going from a range of $10.20 to $11.20 per share to a much lower band of $6.00 to $6.50 per share. With that backdrop, a dividend cut seems like the prudent course of action.
And then fiscal second-quarter earnings came out. Earnings were stronger, but the future seemed to have gotten worse. On the positive side, the huge earnings drop in the fiscal first quarter was not repeated. The second quarter of fiscal 2022 saw earnings of $2.39 per share. That dropped to $1.44 in fiscal 2023, which is double the earnings of the fiscal first quarter. But that's pretty much where the good news stopped.
The bad news keeps piling up
To start off, in the fiscal second quarter, same-store sales fell again, gross profit margin declined, and SG&A expenses rose. Tom Greco, still the CEO at that point, noted that "profitability in the quarter was below expectations, primarily related to our inability to price to cover inflation." And the company again reduced its full-year earnings guidance, this time to a range of $4.50 to $5.10 per share. That's less than half of what it expected at the start of the fiscal year.
While Greco highlighted that same-store sales had begun to turn positive at the end of the quarter, the board still decided that change was needed. Along with the earnings release, the company announced that it had appointed a new CEO, Shane O'Kelly, and brought in a temporary CFO. And within the earnings release it was announced that the company was undertaking a strategic review.
The company is not making these decisions from a position of strength, and that's a troubling sign. In fact, new CEOs often take a kitchen-sink approach when they come on board. Basically, they try to dump all of the bad news they can into the first couple of quarters so they can blame it on cleaning up after previous management. There's nothing wrong with that -- it makes logical business sense -- but such moves may not play well on Wall Street.
Uncertainty is high and the outlook is poor
While Greco's highlight of a same-store sales improvement is good news, there are still a lot of negatives at Advance Auto Parts. Weak financial results and lowered financial expectations are just the start of the concerns that investors should have.
With a new CEO and a strategic business review, the future is hazy at best right now because there could be drastic changes in store for the company and investors. There's just no way to know where the company will go from here until new CEO O'Kelly gives more guidance on what the future will hold. This is something of a turnaround stock at this point, which makes it most appropriate for aggressive investors.
Any dividend investors who are still in the stock, meanwhile, might want to reconsider their commitment -- if not now, then after the strategic review leads to a strategy update. It seems likely that this retailer won't be the same dividend stock in the future that it was in the past.
