Advance Auto Parts' (NYSE:AAP) stock price jumped sharply in mid-October after the company disclosed the acquisition of privately held General Parts International, the largest owner of Carquest-branded auto-parts stores.
The move catapults Advance Auto Parts into the No. 1 industry position, with approximately $9.2 billion in combined annual sales, putting it ahead of major competitors O'Reilly Automotive (NASDAQ:ORLY) and AutoZone (NYSE:AZO). It also adds greater geographic diversity and a foothold in the West Coast, an area that Advance Auto Parts had not previously ventured into. So, should investors buy into the updated story?
What's the value?
Advance Auto is currently the smallest of the three retail auto-parts empires, with roughly 4,000 stores spread around the country. Like its aforementioned competitors, the company has benefited from the economies of scale implicit in national operating footprints as well as sales gains from the general trend of consumers holding on to their vehicles for longer periods. According to the Automotive Aftermarket Industry Association, the average age of light vehicles rose from 10.3 years in 2008 to 11.3 years in 2012.
In fiscal year 2013, Advance Auto has continued its profitable growth, with sales up roughly 4%, as it added new stores and integrated its December 2012 purchase of BWP Distributors and 124 related stores.
However, Advance Auto's operating profitability continues to trail that of O'Reilly and AutoZone due to its negative comparable-store sales and the costs of maintaining a relatively larger store support network of distribution centers.
Advance Auto's purchase of General Parts, though, should improve the combined company's operating margin, as it leverages existing infrastructure, with management estimating operating synergies of around $160 million.
Sticking with efficient operators
While Advance Auto likely increased shareholder value with this latest transaction, a view that investors apparently embraced with the recent stock pop, it will take time for the benefits to be felt in the bottom line. As such, investors should likely stick with the company's archrivals, which both have greater operating margins and better store concentrations in the heavily populated areas of Texas and California.
For its part, O'Reilly has continued building on its 20-year track record of rising comparable-store sales, with a 3.9% increase in fiscal year 2013. The company improved its operating margin to 16.9% during the period, versus 11.2% at Advance Auto, as its new stores leveraged an existing network of 24 distribution centers.
More important, O'Reilly continues to generate substantial operating cash flow, which is allowing it to further expand into growth auto markets, like Florida, while returning capital to shareholders through stock repurchases.
Meanwhile, AutoZone may have temporarily lost its title as the largest retail auto-parts empire, but it continues to be the most profitable, generating an operating margin of 19.4% in fiscal year 2013. A big reason is the company's high level of store productivity, with higher average per-store sales than either Advance Auto or O'Reilly.
In addition, AutoZone's profitability benefits from its growing, high-margin Alldata technology subsidiary that provides repair diagnostic and shop-management software to a growing network of independent shops. Like O'Reilly, AutoZone's high profit margin leads to strong operating cash flow that it is using to expand its operations domestically and in select international markets, including Mexico and Brazil.
The bottom line
Advance Auto's combination with General Parts certainly boosts its overall attractiveness, adding thousands of company-owned and affiliated locations to its existing store network. The company was significantly underleveraged relative to both O'Reilly and AutoZone, with roughly $38 million of net long-term debt as of September, and its acquisition will likely provide a higher cash return than the funds would get by sitting in bank accounts.
In addition, the purchase brings General Parts' Worldpac unit into Advance Auto's fold, immediately positioning it as the No. 1 domestic distributor of auto parts for import vehicles.
However, Advance Auto still needs to find a cure for the negative comparable sales in its overall store network, a trend that has not yet shown up in the results of its competitors. The combining of duplicate General Parts stores in Advance Auto's markets should hopefully generate improved business at its existing stores, leading to higher comparable-store sales.
Until the benefits of the transaction start showing up in the numbers, though, investors should take a pass on Advance Auto in favor of its more efficient competitors.