One of the hottest sectors in the stock market over the past few years has cooled off significantly at the start of 2011. With the exception of Pep Boys
The likely catalyst for the recent sell-off is the overall improvement in new car sales, and January was another strong month comparatively. Numbers released Tuesday showed that combined January U.S. sales of the top seven automakers improved 17.7% over the prior year, and Ford
While improving car sales might have a very marginal effect on these parts retailers, I don't believe the pace at which the industry is growing is enough to impact earnings. New car sales still remain well below historical levels, and the all important "SAAR" -- seasonally adjusted annualized rate of vehicle sales – actually decreased in January. Additionally, Ford's earnings report shows a full recovery is not quite on the horizon. While I believe industry trends are still favorable for the auto parts retailers, there are a few important factors that investors should look for when the group begins reporting this week.
The right conditions
A rudderless economy benefitted parts retailers as new car buying came to a screeching halt during the recession. Consumers were taking their vehicles to repair shops or even fixing them the old-fashioned way, with their own tools. Perhaps the biggest beneficiaries were AutoZone
While a weak economy certainly helped boost the average car's age, cars are made better today, and as a result can be kept much longer. These older cars are mostly free of dealer warranties, and repairs go to independent shops serviced by the aftermarket.
Push for commercial sales
As more and more auto repair work goes to independent shops, the retailers have been looking to boost commercial service to gain a larger share of this highly fragmented $40 billion market. O'Reilly is the leader in this space, generating 50% of its revenue from commercial sales, which is still only about 6.6% of the commercial market. Advance's commercial sales represent 34% of its revenue or 4.9% of the market, and AutoZone is the leader in the retail space, but generates only about 11% of its revenue from commercial sales, or about 2% of the commercial market.
As these retailers attempt to add more commercial sales to the revenue mix, investors need to keep a particularly close eye on margins as well as accounts receivable. Commercial sales generate a smaller margin, as prices are significantly lower for more knowledgeable mechanics and independent garages than for retail customers. In addition, these parts are often delivered to the mechanics by the stores free of charge. With gas prices on the rise, obviously so are costs for these retailers.
Commercial customers are also typically given credit with the option to pay monthly. As the retailers open up more and more lines of credit to customers, investors must watch to make sure the receivables ledger is not expanding too fast.
Throughout the past year, the parts retailers have seen a significant lift from weather conditions. The industry thrives on extremes. The summer was extremely hot; the winter has been just the opposite. AutoZone CEO Bill Rhodes attributed 20% of the company's same-store sales increase during its last quarter to the weather conditions.
Time to wait
The slowly recovering economy is still a positive for the aftermarket, and the trends that have buoyed the industry remain intact. However, those looking for a reason to sell these stocks after a great run have been given a good excuse as a result of the comparatively stronger U.S. new car sales data over the past few months. While not insignificant, I believe investors should keep a closer eye on the trends I discussed and how these retailers are progressing with commercial initiatives, and the higher costs of growing this business.