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Yesterday Advance Auto Parts (NYSE:AAP) hosted its 5th annual analyst day. Appropriately, the even was held at the New York Stock Exchange, as the day also marked the 5-year anniversary of the company becoming a public company. I did not make it up to the conference this year, although in hindsight maybe I should have.

Most of the analyst reports are focused on management lowering 4Q and even their long-term earnings growth target. I’ll get to that eventually, but to be honest, it is no where near some of the most important things that came out of the conference. Anyone can regurgitate the headline numbers. But it tells you nothing about the real inner workings and thought process of management. Specifically with the idea in mind, where do they want to take the company?

As you may have noticed, today’s piece began with a summary from the book “built to last.” The book is a result of the authors James Collins and Jerry Porras studying 18 well known, well established “visionary” companies compared to their counterparts in order to find patterns between the visionary companies. I have never read the book and to be honest a number of the things raised in the summary caused me to scream “thank you captain obvious,” or how does this esoteric stuff impact my company? Remember I too am a business owner, a stakeholder if you will, as Roger Penske always says, not a steward of shareholder resources.

In any case, as I listened to the replay of the Advance Auto Parts Analyst day, one of the most impressive speakers was a guy by the name of Elwyn Murray, Executive Vice President of Administration for Advance. I don’t think I have ever met him before, but I sure think he had a lot of great thoughts about how to make Advance a better place. But I think it was Mr. Murray’s reference (and use) of the book “built to last” that impressed me most. Specifically, he referred to a part of the book that discussed “the genius of the and” versus “the tyranny of the or.” In other words, it is either or, it is never and. And one area you constantly see this ideology/approach (of either or) is when we look at service versus profits. Either you can improve service levels (from higher costs and lower profits), or you can improve profits (at the expense of service levels). In the area of logistics, Mr. Murray proudly exclaimed, it is an area where they have been able to do both!

And I have seen countless instances where lower costs have actually improved customer service. You hear me talk about this all the time when I am discussing moves to a more efficient store format. The idea of centralizing/specializing functions should not be something that lowers costs (at the expense of service), It is an idea that should improve service, because it allows managers and other personnel to focus on the core aspect of their job (which should either be the development of their personnel, or directly dealing with the customer.) Granted, the transition of relinquishing control, culturally, sometimes is tough, but once the culture is changed, amazing things can happen.

I still remember AutoNation’s (NYSE:AN) former CFO Craig Monaghan explaining that to me: “the technology is there, it is changing the culture that takes so long.” On Wall Street, we simply think all it takes is a good idea, and bam, instantly everything changes over night. It would be nice if it worked that way, but sadly it does not. And so I found it surprising to hear one of the large auto retail groups (in the DIY category, which I consider a lot more “mature” in its evolution toward centralization/systematization), like Advance discussing how they plan to lower SG&A (selling, general and administrative expenses) by centralizing corporate purchasing.

Mr. Murray said Advance has something like $750 million in corporate purchases, ranging from capital items like tractors and trailers to copy centers and supplies. Their first goal as a team is to get involved in as many of these purchases as possible, and then target 10% savings. So next year, I think they are targeting $30 million in savings, it means they plan to be involved in $300 million of those purchases in areas everywhere from the auto fleet to information technology hardware and software.

Step 1, therefore is getting involved in the purchasing function. And what it obviously does is allows for greater negotiations (purchasing leverage) with suppliers. But it doesn’t stop there. Mr Murray also went into how once the company is involved in the buying, they can start to monitor (and eventually lower) usage. For example, are employees at store A for some reason making 3x the number of copies as store B on the other end of town, even though store A has half the employees of store B. Now it could be because store A does more “guerrilla” marketing with flyers. Or it could mean someone(s) at store A are using the copier for personal use. But at least centralizing some of this purchasing increases visibility and invites the question (about why so many copies are being made at store A), helping to curb improper usage.

Mr. Murray also emphasized looking at “life cycle usage.” This is an idea I have raised in other notes. You can’t just look at procurement in a vacuum, with one group that purchases the product (at the lowest cost), one that uses the product, and one that repairs it. You need to incorporate the total “life” cost of the product (and benefits from using the product) into the purchase decision.

Now I constantly hear from entrepreneurial run (but often times owned by larger auto retail groups) that big bad corporate is trying to centralize these functions and they are messing things up. They end up not having the supplies they need, when they need them. And what’s worse, is that then they are often told where to buy stuff from (because of a corporate agreement) and the GM or store or facility manager (depending on the type of auto retail establishment) could go down the street and buy the product for cheaper than where corporate is making them buy the product from.

The above is a perfect illustration of how we on Wall Street hear great ideas, and think “poof” automatically things (at the company we are invested in) will get better. Usually (not always) they initially get worse, not better. True, you may lower purchasing costs by 10% like you target, but now you’ve got some disgruntled employees and service levels may initially be dropping. Although, as I indicated above, at least in the area of logistics, Advance seems to be pretty good at smoothly transitioning to more efficient methods that are both cost effective and improves service levels. But most of the time, I think the above illustration of supplies being mismanaged and purchased at too high a price (versus just going down the street) is the more typical experience when power is ceded to corporate.

However, the solution is not to abandon the initiative. Instead, the emphasis needs to be on figuring out where things broke down. This is one of the really good (but seemingly minor) things AutoNation did with their shared resources center. They changed the name to shared services center. Although here again, I question if AutoNation management is now committed to the shared services center (due to management changes). But if they remain committed to the program, the idea of it being a services center is exactly the approach I think every auto retail establishment needs to keep in mind when they are thinking about centralizing various administrative and/or purchasing functions.

The group (at corporate) is serving the stores. The stores are Corporates’ customer, and they (corporate) need to focus on improving the store employee/managers’ experience. And like I said earlier, it therefore should not be an either or of lowering costs or improving customer service. A store manager at Advance or even one of AutoNation’s Ford stores not having to worry about ordering (or paying some one to work for them to order) copy or IT supplies for their office/store should free up time to focus on personnel development. But the service levels to the store personnel need to be measured when you start shifting more (administrative) control over to corporate and away from the store.

And this is one of the other areas that impressed me most with Advance Auto Parts presentation to investors yesterday. Before Mr. Murray spoke, another dude by the name of Keith Oreson (Sr. VP of Human Resources), got up and spoke. On the area of culture, he said one of the biggest challenges the company has is perpetuating a great culture as the company continues to grow in size. And clearly the key here is communication. Now management said they are pretty good at communicating “down the chain” with things like a weekly email update and Advance Auto Parts TV. But they have also started polling members, so they can receive feedback from their employees.

Feedback is something that I think needs to be emphasized throughout all of the companies in the index, and yet it is the first time I have heard it raised on an investor call. Sure, you may be communicating great with your employees (in delivering your message), but how well are you soliciting feedback from the people in the trenches? I give Advance Auto Parts management a lot of credit for trying to make the communication with their employees more of a two way street. Importantly, finding ways to solicit feedback (with polls even a corporate services CSI scorecard) from your employees is imperative if you are centralizing administrative/purchasing functions.

So those are some of the positives I found from listening to the Advance Auto Parts Analyst Day. I’ve already written a couple times about how I am encouraged with the company’s AI (commercial business) acquisition, so I don’t see a reason to go into it again. Although I did not like hearing management discuss how they want to keep AI almost entirely commercial (jobber) business model versus shifting it to become more similar to O’Reilly where they can be 50% commercial/50% do-it-yourself [DIY].

And now I guess it is only appropriate that I point out a few of the negatives. Although the first negative, I could almost classify as a positive. CEO Mike Coppola was very clear about the objective of the company: to be the auto parts provider to the individual person. He said they are not in heavy duty and the commercial business is strictly for profits, but the reason they are in business, the vision and mission of the company is auto parts for the individual. I tend to hold a different view than Mr. Coppola that the commercial business is where the growth is at in the market. But I can not emphasize enough how much I respect Mr. Coppola stating clearly who they are, what their mission is, and who their customer is. Far too often I think management teams go awry by trying to be everything to everyone.

And given my view that the DIY market has become saturated, it should not surprise investors that during the event CFO Michael Moore said comps in the first seven weeks of the quarter were running at the low end of their range of 1% to 3%, and so 4Q earnings per share (eps) would likely be at the low end of their range of $0.33 to $0.37 I encourage investors not to fret about quarterly earnings.

Perhaps what was more important out of management was the “chatter” that the company was lowering their long-term earnings per share growth target from 20% to 12% to 15%. I did not see a press release, although maybe it was in the slides (that are not up on the website). Mr. Coppola referenced (both in his opening remarks and question and answer session) this “chatter” never acknowledging or denying the new eps growth target. But he did say things like “why over promise and under deliver” and that this year has been a bit of a “wake up call” with the macro environment, so until they can see some change potentially in 2007, for some time they are going to be a little more conservative in their outlook.

I think all of you know my differing opinion about the weakness at Advance being more reflective of a structural shift in the industry (as a result of market saturation) versus “macro factors.” Improving sales results at competitors like AutoZone (NYSE:AZO) (although recently they seem to have reversed course and started letting sales slip again so they could regain profits), while Advance’s sales slip seems too telling that it is more competitive versus macro factors. Advance management insists they are gaining market share, and this may be correct because AutoZone has negative same-store sales and so is probably still losing market share. But Advance is probably gaining share at a slower pace than they once were. And I still think accelerating square footage growth at this juncture is a recipe for disaster.

Importantly, while I am a bit confused about the “official” long-term guidance, preferring a press release had been issued, I think it is pretty clear management is no longer suggesting to investors they plan to generate 20% annual eps growth. For investors, this is HUGE, because the growth expectation is ultimately (albeit I am simplifying things) what determines the price (multiple) investors should be willing to pay for a stock. Lowering the growth target therefore has a direct impact on the value shareholders should be willing to place on the shares and this is likely why you saw the shares drop over 5% yesterday (although they rebounded a bit today).

This is one of the toughest things for a management team to do. And while it came across as somewhat temporary I think many investors recognize that this is the new growth target for the company. 12% to 15% is not bad. Far too often I have seen management teams sit in denial that the underlying growth dynamics of their company have changed (usually industry driven whether you agree with me that it is structural or management that it is macro), and end up doing things that are not in the best long term interest of shareholders in order to keep trying to grow at their customary growth rate.

Lowering your long term growth target is painful, tough to swallow, and bites into your pride. What usually ends up happening is that the company hits such a wall that a new management team comes in with a new approach and new growth rate (often times with a 12% to 15% growth rate now looking attractive after the company had hit said “wall”). So management easing investors into this lower growth expectation (saying hopefully things will change in the macro environment so they can bring the target back up), for the next few years should be commended. It means management is focused on the long term, not in trying to meet a short term 20% eps growth target (where if they stretched, who knows maybe they could have, but at a serious expense of the long term). Now if I could only get management to stop building DIY stores.

But I want to end with reminding investors with the opportunity that I think awaits Advance 5 – 10 years from now, which potentially re-defines the way consumers think about the automotive aftermarket. I heard management on the call talk about the new ways to reach the consumer like the cell phone and podcasts. You’ve heard my thoughts about Amazon entering the market, and I think that if Advance management is proactive, in 10 – 20 years from now they can be part of the process the most efficiently distributes the part to where it is needed. But, management needs to begin today in changing the way they approach the market. From trying to predict demand to trying to get the part to where it is needed.

I have talked in various issues about how remote vehicle diagnostics is already beginning to be used in fleets. In 20 years from now I suspect even the consumer market will have fully moved to a system where the type of repair (and part) needed is well known hours (if not days) before the vehicle even arrives in the repair shop. If this is where the market is headed, the core competency, the idea of having great stores that can “predict best” where and what parts are needed (but still turning the part less than 2x a year) goes away. Instead, it is replaced with establishments that can best (most efficiently) distribute the part. Either leading retail and jobber establishments recognize the coming shift in the market and begin to shift their culture today to an idea of reacting to demand best versus predicting demand best, or they will be replaced by new entrants like that are not inhibited by existing cultures and biases to certain approaches.

This is why I continue to encourage auto retailers (like auto parts stores such as Advance and AutoZone) to begin experimenting with offering discount to consumers that order products online and pick it up at the store, or even if they call ahead and put an order in ahead of time you give them a 5% or 10% discount. This way the store now has booked in their system a sale hours if not a day or so in advance, causing the replenishment product to begin the process of being shipped to the store. Eventually this should help move the company into carrying a smaller depth of products (so only one pair of brake pads for a particular vehicle line,) but potentially a greater number of stock keeping units (SKUs), so for example, a greater number of brake pads for different (more rare) vehicle lines.

The other thing (that I will conclude with) that David Mueller, Advance’s VP of Marketing and Merchandising mentioned was that they are finding consumers are calling their stores and using them as a resource center (“almost like a pharmacy”). I can not emphasize enough, whether you are Amazon, AutoZone, NAPA, or a public dealer group, how you need to have a consumer resource center. Create an online 24/7 chatline, telephone line, and email system where consumers can reach experts any time of the day with their questions about their vehicle (the purchase of a vehicle or about problems with said vehicle).

By turning yourself into a resource center, you significantly improve the odds the customers will go to you when they need to make a purchase or repair. And ultimately, by beginning as a resource center, you ultimately should be able to refer business into your store base and therefore allow your people (once again) to react to demand versus try to predict, because they should have a good idea long before the customer has even arrived what they are looking for. The idea of sales, very simply, when we get to “Jerrytopia” will have changed from that of a “push” to “pull” approach.

AAP 1-yr chart:

AAP 1-yr chart

Have a great weekend.

Source: Advance Auto Parts Analyst Day Celebrates 5 Years As a Public Company - What Next?