Shares of Advance Auto Parts (NYSE:AAP) caught our attention last week after the stock lost gas due to a lower-than-expected earnings report. Shares are currently trading 20% below their 52 week high of $47.73. Earnings surprises can turn into great buying opportunities, if you've done your homework. Here's a quick peek under the hood of this maligned wonder.
Description: Advance Auto is the second largest automotive products retailer. Products include replacement parts, accessories, maintenance items, batteries and automotive fluids for cars and light trucks (pickup trucks, vans, mini vans and sport utility vehicles). Advance also serves the professional installer market, which represents about 22% of sales. AAP operates close to 2900 stores in the US, PR, and the Virgin Islands. Of the 16 analysts who cover the stock, none have yet to push the sell button.
Positive Considerations: Advance Auto Parts announced disappointing 1Q EPS of 68 cents per share, which the company said reflected higher energy prices and mild winter weather. Total sales at the replacement car parts retailer increased 11% to $1.39 billion up from $1.26 billion, at the low end of the company's 1Q guidance. RBC Capital Markets noted that Advance Auto Parts spent heavily on its store growth (as many as 200 units expected to open in 06), explaining why operating expenses were higher-than-expected. But then RBC went ahead and maintained their buy rating and $50 price target on the stock.
Advance Auto is a stable, growth story. The Automotive Aftermarket Industry Association [AAIA] thinks that the demand for auto repair will grow in the mid-single digits for next few years. Advance Auto has been using this period of calm to revitalize in-store formats in order to drive top line narrative and lift profitability. Although the last quarter may have been bumpy, management insists it'll hit these goals through creative inventory mix, brand enhancement and higher same stores sales. In a world where #2's rarely win, Advance Auto finds itself well capitalized and strong enough to capture customers that the industry leader is unable to serve, whether it be for geographic, qualitative, or quantitative (price driven) reasons.
Risks: A pop in fuel prices would clearly hurt shares of AAP, as could developments and earnings acceleration from rival Autozone (NYSE:AZO), which remains the undisputed leader in this space. Autozone also plans to expand which could portend possible product overlap between both stores. Such a scenario would adversely impact shares of Advance Auto, whose margins would further compress (as the runner-up, AAP will be forced to boost SG&A). Lastly, AAP's Chairman made a killing selling stock in 2005; more insider selling in 2006 would exacerbate uncertainty within the investment community and possibly trigger further price depreciation.
Valuation: Analysts expect AAP's 2007 EPS to jump 19% to $2.85, leading us to believe that shares look fairly valued at current P/E valuation. However, we think the market is overlooking the fact that Advance Auto has boosted its ROE more than 200% in the last 5 years while cutting debt by 50% to $477 million. AAP trades at a discount to its peer group on both a PEG and price/cash flow basis; given robust store expansion plans and upcoming summer season, we see further upside and leave price target at $48, representing a 20% premium to yesterday's closing price.
AAP 1-yr chart