Advance Auto Parts (AAP) posted solid results this week as the company continues to make progress on the integration of General Parts in order to deliver on promised cost synergies going forwards.
This deal, and the great long term value creation through growth, acquisitions and share repurchases are appealing attributes of the company. The higher valuation and higher leverage limit the immediate appeal in my eyes, leaving me awaiting a potential correction or pullback at some point down the road.
Strong Second Quarter Results
Advance Auto Parts posted second quarter revenues of $2.35 billion, a 51.5% improvement compared to last year. Of course the impressive numbers are driven by the acquisition of General Parts. Reported revenues came in ahead of consensus estimates at $2.32 billion.
Reported earnings rose by 19.3% to $139.5 million as GAAP diluted earnings rose by a roughly similar percentage to $1.89 per share.
Adjusted earnings of $2.08 per share beat consensus estimates by seven cents.
Looking At The Real Performance
Of course the vast majority of reported revenue growth was related to the General Parts acquisition as comparable store sales for the quarter came in at 2.6%.
Gross margins were down by a full 5 percentage points to 45.2% of sales. The commercial business of the acquired General Parts reports much smaller gross margins compared to the do-it-yourself business, explaining the compression in margins.
This also explained the fall in relative selling, general and administrative costs which fell some 350 basis points to 34.1% of sales. Synergies have been helpful as well of course, although most of the benefits from the year still have to materialize in the future.
While the reported GAAP earnings of $1.89 per share have been reasonably impressive, this came after the company took some charges already. Adjusted for these items, consisting out of impairment charges and integration costs, earnings rose by 30% to $2.09 per share.
At the end of the quarter the company held about $67 million in cash and equivalents which results in a net debt position of roughly $1.8 billion.
With 73.4 million shares outstanding at the end of the quarter, and shares trading at $131 per share, equity in the business is valued at $9.6 billion.
This values equity in the business at roughly 1 times sales. The company upped its full year earnings forecast from $7.30-$7.50 per share as previously guided, to $7.50-$7.60 per share. This values equity at 17-18 times anticipated annual earnings. The revised full year earnings guidance was largely in line with consensus estimates.
The Recent Investor Presentation
Back in June, Advanced Auto Parts held its investor presentation stressing the long way which the company has come so far. Numerous acquisitions including last year's big one added significantly to the store count, with the company now also servicing independent-owned stores. The company is furthermore shifting towards a 50-50% mix in the do-it-yourself and commercial business.
Advance Auto Parts is seeing major tailwinds as the average age of cars on the roads continues to increase, unperformed maintenance is up and average selling prices of spare parts increase due to ever more complex cars.
With the acquisition of General Parts the company became the number one automotive aftermarket parts provider of the US, with scale and leading brands adding to its advantage. This strategic advantage will aid the company in the coming years as the integration will furthermore unlock financial synergies.
The new combination has over 5,400 locations including 1,400 independent locations being acquired with the General Parts deal. The new company is on track to post sales of $10 billion for next year, marking a doubling in sales since 2008 when Advance posted annual sales of about $5 billion.
The integration efforts should allow the company to cut costs by some $50 million this year with management stressing that integration is on track. Synergies are anticipated to increase towards $160 million by 2016.
The company has created a great track record over the past decade growing revenues of the business at mid-single digit growth rates. Solid organic growth, bolt-on acquisitions and the latest sizable deal were the drivers behind the advancements on the top line of the income statement.
The impressive part of this growth is that the company managed to grow the business without diluting the shareholder base. In fact the company has reduced the outstanding share base by some 35% over the past decade. As such earnings rose from less than $2 bucks in 2004 to over more than $7.50 as anticipated for this year.
The latest deal resulted in some leverage, yet the net debt ratio of about 3-4 times annual earnings and less than 2 times EBITDA is very much manageable and no imminent threat. I take into account that the company's earnings and cash flows have been very resilient even during the 2008-2009 crisis.
Back in May I last checked upon the prospects for the company following the release of the first quarter results which were aided by the harsh winter conditions at the start of the year.
I noted that investors have been rightfully very upbeat about the company's $2.0 billion deal to acquire General Parts. The estimated $160 million annual synergy estimates are very sizable in relationship to the deal tag, creating much of the appeal.
I concluded that given the leverage incurred with that deal and the valuation which is at par to that of the wider equity markets, I did not believe that shares were an obvious buy. While I very much like the track record, the predictability of earnings and growth prospects I would like a bigger margin of safety as a result of the leverage incurred.
Therefore I set a 15-16 times earnings multiple to a potential entry point. This arrives in a $110-$120 target at which I would be very happy to pick up some shares in this quality name.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.