It's always useful to keep an eye on insiders buying stock in their own companies. It's particularly intriguing when management is doing it while integrating a major acquisition. With that in mind, Fools should keep a close look out for stock in auto parts retailer Advance Auto Parts (NYSE:AAP).
Earlier this year, the company completed the purchase of General Parts International -- owner of Carquest and Worldpac stores -- for just more than $2 billion. If the insider buying is a good tell, then the integration plan is working out just fine. It's time to take a closer look.
What the deal means for Advance Auto Parts
The market certainly likes the deal, because Advance Auto has noticeably outperformed its peers Autozone (NYSE:AZO), Genuine Parts Company (NYSE:GPC), and O'Reilly Automotive (NASDAQ:ORLY) in the year since it was announced.
Advance Auto Parts benefits in three major ways from the deal. First, General Parts had 80% of its revenue in the commercial market (20% DIY). The addition of its business is forecast to shift Advance Auto's revenue mix to 57% commercial from 40% previously.
This is good news for Advance Auto because, according to CEO Darren Jackson at the company's investor day in June, "You can see that the commercial market continues to outpace the DIY market 3 to 1." In a sense, the acquisition allows the company to accelerate the process of shifting its revenue mix away from its historical DIY base, which, according to Jackson, "used to be 84% of our business a decade ago."
Second, the deal is a good geographic fit, as Advance Auto previously had 87% of its stores in the eastern half of the U.S. General Parts is strongly represented on the west coast and Canada.
Third, the price paid appears to be excellent for Advance Auto. At the time of the deal, management disclosed that the price paid was an EV/adjusted EBITDA of 9.3 times. Enterprise Value, or EV, just represents the price of the company, and EBITDA is Earnings Before Interest, Tax, Depreciation and Amortization. It's the most commonly used metric in takeover activity. However, Advance Auto expects to generate $160 million in annual run-rate synergies by the third year following the deal and, including these synergies, results in an EV/adjusted EBITDA ratio of just 5.4 times.
To appreciate just how cheap this looks, readers should note the current EV/EBITDA valuations in the following graph -- also note the run-up in Advance Auto's valuation.
Current trading positive
A quick look at its results so far this year also reveals that the company is doing well -- another reason for insiders to be buying. On a negative note, gross margin declined from 50.1% in the first six months of last year to 45.4% this year; but this was attributed to the higher mix of commercial sales as a result of the acquisition -- commercial sales tend to be lower margin. However, Advance Auto managed to increase its comparable same-store sales by 2.5% -- the figure doesn't include same-store figures from General Parts -- and management declared itself to be "on pace against its business expectations."
Indeed, "on pace" might be all the company needs to do to appreciate. For example, a look at forward EV/EBITDA -- one year ahead forecasts that help investors price in future growth -- shows that Advance Auto looks cheap compared to its peers.
In fact, the average of the forward EV/EBITDA ratios for its three peers is 10.4, implying that Advance Auto has a 13% upside potential just from hitting its targets.
However, investors need to keep an eye out for one concern with the company -- its inventory management. In the last two years, Advance Auto's inventory turnover -- how many times it turns over its inventory, with a larger number being good -- has declined. Carrying lots of inventory is not great for cash-flow generation, because it means cash is tied up in holding inventory. Indeed, as the second chart below shows, this has helped cause free cash flow to assets to decline in recent years. This is not good.
Investors should follow this figure closely in future quarters because, theoretically at least, the greater scale acquired with General Parts should create some opportunity for Advance Auto to improve inventory turnover in future years.
All told, Advance Auto looks on track with its acquisition, and its management appears confident enough to buy stock. Despite the strong rise in the stock price, the shares still look cheap, based on forward EV/EBITDA estimates, compared to its peers. However, Fools should keep an eye out for how its inventory management develops going forward.