Which Is the Best Auto-Parts Supplier for Your Portfolio?

Aftermarket retailers have done very well in 2013, benefiting from an increase in the average age of vehicles. The likes of AutoZone (AZO 0.03%), Advance Auto Parts (AAP 0.58%), and O'Reilly Automotive (ORLY -0.97%) have beaten the market as the average age of light vehicles in the U.S. reached an all-time high of 11.4 years at the beginning of the year, according to data from Polk. Moreover, it looks like people are keen on keeping their vehicles longer, as during the past five years there has been a 20% jump in the number of vehicles older than 12 years.

Hence, the conditions have been conducive for the industry as a whole, but there are changes brewing underneath. Auto-parts retailers and service providers are seeing greater opportunity in the commercial (do-it-for-me) market due to the complex nature and advanced technology of vehicles nowadays.

Racing ahead
Advance Auto Parts made a big move recently when it announced the acquisition of General Parts International. After completing this acquisition, Advance Auto will become the largest auto-parts retailer in North America with more than 5,400 stores, putting it ahead of both O'Reilly and AutoZone. 

More important, Advance Auto will be able to fortify its position in the commercial market better through Worldpac, which is a supplier of replacement parts for imported vehicles. This is a pretty logical move on Advance Auto's part, as its management believes that the commercial market is growing twice as fast as the do-it-yourself segment. According to Advance Auto, the commercial market is currently worth $40 billion, and hence the company is looking to make the most of it by expanding its network. 

Advance Auto has consistently worked toward improving its commercial capabilities. It acquired 124 stores of BWP Distributors earlier this year to bolster its presence in the Northeastern market. Thus, it looks like Advance Auto is probably the best-positioned company of the three when it comes to benefiting from the commercial market.

AutoZone: Starting off now
However, competition is not far away, as both AutoZone and O'Reilly are strengthening their positions as well. AutoZone, which reported its first-quarter results in December, reported better-than-expected results due to its focus on the commercial market. In addition, colder weather has been a tailwind for auto-parts retailers and AutoZone also benefited from it.

David Schick of Stifel Nicolaus believes that the colder weather could lead to good demand for auto parts for the next six months. AutoZone's moves in the commercial arena could further help it improve business. AutoZone started a commercial program in 125 stores last quarter, well above the 37 programs that it had introduced last year. As a result of this initiative, commercial sales increased almost 14% from last year.

Going forward, AutoZone is looking to improve the availability of commercial parts at its hub locations apart from adding inventory at its distribution centers. AutoZone's business from the commercial segment is lower than that of O'Reilly and Advance Auto, which means that the company has more room for improvement.

However, investors considering an investment in AutoZone should take a closer look at its books, since the company is laden with debt and is buying back shares instead of paying the debt off. The company boosted its share-purchase authorization by $750 million and repurchased $292 million worth of shares in the previous quarter. In comparison, its debt stood at a massive $4.2 billion while operating cash flow was only $357 million. 

Best of both worlds
O'Reilly is focusing on both the commercial and do-it-yourself markets. According to Reuters, O'Reilly gets 40% of its revenue from the commercial market. However, O'Reilly is seeing faster growth in its commercial business than the do-it-for-yourself side. As such, O'Reilly is working toward improving the availability of parts in its stores. For this reason, it will relocate its distribution center in Lewiston, Maine, to Devens, Mass., to improve its presence in the Northeast. 

O'Reilly will also open distribution centers in Lakeland, Fla., and Naperville, Ill., as it is aggressively expanding its network. In 2014, O'Reilly is looking to open 200 new stores as compared to 109 net new stores planned for this year. 

Apart from commercial, O'Reilly is also looking to make its do-it-yourself business better. The company had started a loyalty program in the second quarter of this year, and it seems to be doing well. O'Reilly has already signed up 1 million members under this program and it will be using targeted promotions to grow business from these members. 

Final words
All three auto-parts retailers are looking to make the most of the commercial market. But from an investment standpoint, AutoZone's debt is a cause for concern. Comparatively, both Advance Auto and O'Reilly could turn out to be good investments. Advance Auto, which is on the verge of becoming the biggest auto-parts retailer in North America, will benefit from its wide store network and growing commercial business. On the other hand, O'Reilly is looking set to profit from both the DIY and commercial markets.