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Pep Boys (NYSE:PBY) has finally joined the rest of its peers, (AZO, AAP and ORLY) in the red hot auto parts retailing sector, as its shares have outperformed virtually 99% of NYSE stocks in the last four weeks. There is no doubt that this 88 year old icon is beginning to see some “proverbial” light at the end of the tunnel that Wall Street is starting to recognize, by rewarding it with a substantial markup. Although the company still has plenty of work ahead of itself (its turnaround efforts are in its infancy), it is beginning to fire on all cylinders, albeit at a “baby step” speed.

Share price volatility: It is common knowledge that Wall Street continually overreacts in both market directions. The market has a tendency to get too optimistic when things are going well and too pessimistic when things are not going so well - the pendulum always swings in extremes. The shares should have never been as low as they were last month and likely have been bid up too much in too short of a time frame the last three weeks. It is kind of ironic that when the shares were under $3, nobody wanted to touch them with a ten foot pole, and now that they are getting close to the $7 mark, Wall Street can’t get enough of them. Isn’t this backwards? Shouldn’t the market love the shares when they are cheap and loathe the shares when they get expensive? I guess logic seldom prevails in an environment where fear and greed dominate.

Conference Call Highlights:

  1. First quarter sales trends reveal a 3% service sales gain and a 8% rise in commercial segment revenues coupled with a drops in advertising and labor costs. Gross profit margins are firming as a consequence.
  2. PBY aims to improve market density by adding 15 service centers (service spokes) in 2009 and 20-40 in 2010 with each location expected to generate $1 million in sales per annum.
  3. The company proposes to promote its “29 minute oil“ changes and 59 minute “tire service”, realizing it shortcomings in attempts to provide timely service in the past.
  4. Expects to offer hybrid service by the end of the year.
  5. The company is test marketing a performance shop in one of its Los Angeles stores which will cater to the muscle crowd, import and truck segment.
  6. The company’s rewards program (loyalty) in 50 stores has shown promising results and will be rolled out to its remaining locations
  7. PBY’s new tag line, “Pep Boys does everything for less” will be achieved through enhanced customer service and training.
  8. Management’s mantras are: “back in the black in 2009” and “one more service sale, per store, per day”, represents $40 million in additional sales and $16 million in profit.

Gross profit margin: The company’s historical gross margin on service sales has been near the 20% mark, and with current service margins near the 5% vicinity, the company really has nowhere to go but up. It will be like shooting fish in a barrel, if PBY is able to improve its customer service in the slightest, because with over 6000 service bays present, incremental improvement will effect a dramatic impact on the bottom line. The degree of opportunity in this segment is enormous and represents the widest path to substantial earnings gains. Management has made it crystal clear that the service segment will be their main focus.

Short interest and senior bonds: PBY’s short interest continues to plummet, as it dropped 20% in the past two weeks from 4.17 million shares to 3.31 million shares. In January, PBY had a short interest of 6.9 million shares, so it is obvious that the “smart money” does not want this type of risky exposure anymore. PBY’s senior bonds are also gaining strength as they are trading near the $710 area, up more than 40% since the start of the year. One of PBY’s most informed investors, known as “Daninfw04” (blogging on PBY’s yahoo finance message board) has attracted quite a following (and rightly so, as he has been spot on) and sees the shares reaching the $10 mark as soon as the end of the month. He also indicated that Barrington Capital’s aggressive selling (they cut their position from 6.85% to 5.57%) has hampered PBY’s share price, and without Barrington’s active selling, the stock price would be sitting closer to the $8 mark. The good news is, the “supply overhang” of the hedge fund’s holdings in PBY is starting to diminish.

Conference call disappointments: The fact that PBY did not buy back any of its own bonds or did not give better color on its gross profit margin improvements did not sit too well with me. PBY also failed to address the reality of it being a prime acquisition target and what their strategy would be to fend off a hostile takeover attempt. The company also announced a series of Investor meetings, starting the week of 4/13, but annoyingly, failed to give specific dates.

Bottom line: The trend is your friend and jumping on this momentum train makes sense. The fact that the stock has clearly broken through its 200 day moving average line is welcome news for longs craving confirmation that this turnaround actually has teeth. It seems the company is finally on its way back, and buying at these levels, still offers more reward than risk. It might be too soon to nominate Manny, Moe and Jack as the biggest muscle flexors on the beach, but these former 95 lb weaklings, won’t be having sand kicked in their faces anytime soon, especially if all goes according to plan.

Disclosure: Long PBY.

Source: Pep Boys: Starting to Show Some Muscle