Last Thursday, Advance Auto Parts (NYSE:AAP) reported third-quarter earnings. The discount auto-parts retailer that now operates more than 3,000 stores generated revenues of $1.1 billion, an increase of 7.8% from the third quarter of 2005. The results for the quarter were driven by the strength of its commercial or do-it-for-me business with 11.7% growth. The retail or do-it-yourself business didn't fair as well, decreasing by 0.3%. These divergent results highlight some of the strengths and weaknesses of the discount auto-parts business.
But first, let's look at the rest of the results. Margins for the quarter were mixed. An increase of operating expenses by 200 basis points negated a 100-basis point improvement in gross margins. Forty-two basis points, however, were stock option expenses that were not included in third-quarter 2005 results. Unfortunately, the 1.4% increase in same-store sales didn't create enough operating leverage to offset the increase in cost of doing business. As a comparison, the resulting 9.3% operating margin is a far cry from its more mature competitor AutoZone (NYSE:AZO), which manages operating margins of roughly 17%.
Now, why do I point out the divergent results? Recent investment commentary has focused on the negative impact of rising interest rates and the price of gas. However, you can't peg the success or failure of Advance Auto's investment story entirely on the macroeconomic environment. This might work better for general discounters such as Dollar General (NYSE:DG) and Wal-Mart Stores (NYSE:WMT), which have a greater link to the consumer's discretionary income.
Don't get me wrong -- less discretionary income, as evidenced by the soft retail numbers, also affects Advance Auto. The purchase of a new steering wheel cover or carnauba car wax can be postponed. However, when a car's brakes fail or the muffler falls off, it has to be replaced. It's this power of economic necessity that drives Advance Auto's results regardless of the macroeconomic environment consumers finds themselves in.
The bottom line is that the need to keep cars on the road trumps any discretionary woes an Advance Auto customer might have. As a result, while the stock of Dollar General and Wal-Mart has remained flat over the past five years, Advance Auto's has risen almost 150%. These divergent investment results just like the divergent results in Advance Autos' commercial and retail divisions are a reminder that all businesses are not created equal and a successful (versus lucky) investment thesis must take this into account.
For more advanced Foolishness:
- Advance Auto Parts Stalls: Fool by Numbers
- Advance Auto Parts Standing Still
- Advance Auto Parts Hopes to Steer Past Trouble
AutoZone and Wal-Mart are both Motley Fool Inside Value picks.
Matthew Crews welcomes your feedback at any time -- really! He has no financial position in any of the companies mentioned. The Motley Fool has an ironclad disclosure policy .
