Advance Auto Parts Needs To Take a Page From O'Reilly's Book

Here's a quote from Advance Auto Parts' (AAP) recent conference call:

From a sales standpoint, these past few weeks have been reminiscent of the last two years. During that time we saw significant stretches of both above trend growth and below trend growth. In light of such significant swings, you would expect us to take a step back and reassess our opportunities. And we are doing exactly that!

- Mike Coppola, Chairman, President and CEO of Advance Auto Parts, from 4Q06 conference call

Advance's year-over-year decline in earnings per share in 4Q06 to $0.33 a share from $0.36 last year (granted if you adjust for stock options it basically was flat year over year) was pretty disappointing for such a highly regarded growth retailer. And yet the stock was up nearly 5% Thursday. And you know what? I actually agree with investors that there is some reason for optimism that came out of the company's conference call.

Now I think most of you know my investment thesis (for the last couple years) on the DIY (do it yourself) automotive aftermarket retailers has been that automotive parts are lasting longer than the industry data would lead you to believe, and that the DIY retailers have been expanding too fast and this would not be good for earnings and/or sales. Essentially, the DIY market is becoming saturated and they need to shift their growth into the commercial (service repair) side of the business. But I said these are great organizations. And sadly, when you are a great organization, you often need to hit a wall before you are compelled to change course. Because a shift to the commercial market is hardly as easy as it seems.

Yet, I think Mike Coppolla's (Advance Auto Parts CEO) statement on the company's conference call yesterday morning (opening quote) was a good sign that the industry is beginning to notice something is wrong. Admitting there is a problem is the first step. It is early days, and things (like sales and earnings) may very well get worse in 2007 before they get better.

But it is one of the first signs I have seen that the industry is ready for change. And if things play out as I think they might, it may begin to move automotive aftermarket retailers in a really exciting new direction. One that rewards automotive repair customers and shareholders of auto parts distributors.

What gives me a little more optimism about the space? Mr. Coppolla didn't just say Advance is taking a step back and reassessing opportunities (as I began with in the opening quote). He went on to say that they are using both internal and external resources to help the company understand the growth potential of the business and the major customer segments. He said that the knowledge they gain from this research (hopefully completed by 2Q07) will help them better serve their customers, help define the company's growth strategy, and ultimately help determine where/how the company should deploy its resources going forward.

AAP's slowing expansion strategy
As a result, management said they would slow their expansion strategy. True, the new store growth rate was only slowed from 7.5% to 6.5%. But I think it is a step in the right direction.

Those of you that have been reading me long enough should know that I think the DIY retailers need a two-pronged strategy in order to be more effective in the commercial market. First (in the intermediate term), I think they need to become more like O'Reilly Auto Parts (ORLY) and allow for a more entrepreneurial environment with more variable compensation plans at their service desks and even store employees and managers (it needs to be a part of the culture).

Maybe changing the culture is too difficult, and in that regard you just need to go with brand new "jobber" stores. Jobbers are simply people who distribute parts to professional repair facilities like Jiffy Lube or Midas. I think Advance has some great opportunities to leverage the Automotive International [AI] business that they acquired a little over a year ago. But on the conference call, the company's President, Jim Wade, seemed to suggest that they don't want to grow AI too fast as it could extend (a relatively small company's) personnel too far.

And in the "jobber" world your people are everything! All retailers say that, but in the jobber world it really means something. Why? Because the sale is driven by the relationship between two people: the jobber, and the owner of these independently owned repair shops. This is why it is so important the DIY retailers shift their model (or change their growth strategy to "company owned jobber stores" like O'Reilly so they can become more entrepreneurial (at the store level) while still being able to leverage size and scale.

But the second, longer (in time horizon) shift is to actually change the commercial repair market itself...

AAP 1-yr chart: