Auto Parts Stocks: Shifting Your Portfolio Into High Gear

by: Justin Kuepper

Auto parts and repair stocks have significantly outperformed the overall market over the past month and throughout history. According to Tickerspy's index, the sector has outperformed the S&P 500 by 16.3% this month and 121.9% since January 1, 2008 when the index was started. But, what's driving this performance and will it continue to pay off for investors?

Recession Resistant

Most investors wouldn't have thought of AutoZone Inc. (NYSE:AZO) as the best investment during tough economic times. But those that purchased the stock on the day Lehman Brothers filed for bankruptcy would have made a 176% return on their investment. Moreover, this growth has been a steady incline, making it a very easy stock to own over time.

AutoZone isn't alone either. As it turns out, many auto parts and repair stocks have provided robust returns throughout troubled times. In fact, O'Reilly Automotive Inc. (NASDAQ:ORLY) returned an even more impressive 255% over the same timeframe. And TickerSpy's index has generated returns in excess of 120% since 2008 when the crisis began.

Taking Apart the Engine

These recession-resistant qualities beg the question: What's driving these oversized returns for auto parts and repair stocks? To answer this question, it's best to examine some SEC filings to determine whether financial results are at the heart of this growth and whether that performance is sustainable enough to justify price-earnings multiples.

AutoZone is the largest player in the group with a market capitalization of $15 billion, making it a bellwether of sorts for the industry. The company's SEC filings have also elaborated on some of the key drivers within the industry, as well as potential risks to those drivers. According to its most recent MD&A within its 10-Q filing with the SEC:

Net sales were up 8.6% for the quarter, driven by domestic same store sales growth of 5.9%. We experienced sales growth from both our retail and commercial customers. Earnings per share increased 24.4% for the quarter.

Over the past several years, various factors have occurred within the economy that affect both our consumer and our industry, including the impact of the recession, continued high unemployment and other challenging economic conditions, which we believe have aided our sales growth during the quarter. As consumers' cash flows have decreased due to these factors, we believe consumers have become more likely to keep their current vehicles longer and perform repair and maintenance in order to keep those vehicles well maintained.

More recently, we feel other macroeconomic factors have adversely impacted both our consumer and our industry. During the second quarter of fiscal 2012, the average price per gallon of unleaded gasoline in the United States was $3.52, up $0.38 or 11% from $3.14 in the comparable prior year period. We believe that the increase in gas prices is reducing discretionary spending for all consumers, and, in particular, our customers.Historically, the two statistics that we believed had the closest correlation to our market growth over the long-term were miles driven and the number of seven year old or older vehicles on the road. While over the long-term, we have seen a close correlation between our net sales and the number of miles driven, we have also seen short time frames of minimal correlation in sales performance and miles driven.

There are several important takeaways to these rather insightful comments:

  1. Profitability and same-store sales are improving at a fairly rapid clip, which suggests that customer demand is strong and the company controls pricing, making P/E's fair.
  2. Challenging economic conditions have led to consumers keeping older cars longer, which require increased maintenance and boost the company's results.
  3. Higher gasoline prices could impact consumer spending, which may have a negative effect, but transportation remains high on the food chain when it comes to cutbacks.
  4. Miles driven and old vehicles on the road are two statistics that closely impact the company, and the average car on the road has never been older.

Buy High, Sell Higher?

Many investors are hesitant to purchase auto parts and repair stocks because many of these stocks are trading near their 52-week high. Of course, the same argument could be made at almost any point between 2008 and today. So, what's the best way for investors to gain exposure without buying too high?

Buying on small dips and averaging in over time is one way to build a position without buying at the top. But investors may also want to consider simply hedging their bets when buying. For instance, writing covered calls can generate an income at no risk (other than selling too soon) that can help offset the original cost over time.

Stocks in the sector to consider include:

  1. Advance Auto Parts Inc. (NYSE:AAP)
  2. AutoZone Inc.
  3. Genuine Parts Company (NYSE:GPC)
  4. LKQ Corporation (LKQX)
  5. Monro Muffler Brake Inc. (NASDAQ:MNRO)
  6. The Pep Boys (NYSE:PBY)
  7. U.S. Auto Parts Network Inc. (NASDAQ:PRTS)

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.