Why The Auto Parts Retailers' Performance Was Surprising

Includes: AAP, F, ORLY
by: Valuentum

Last week, Advance Auto Parts (NYSE:AAP) and O'Reilly Automotive (NASDAQ:ORLY) posted better than anticipated fourth quarter results. Revenue at Advance Auto Parts was roughly flat year-over-year at $1.3 billion, in line with consensus estimates. However, the firm's bottom line surprised materially to the upside, with earnings in the quarter decreasing just 2.2% on a year-over-year basis to $0.88 per share. O'Reilly's fourth quarter was even more impressive, with revenue jumping 7% year-over-year to $1.5 billion, a touch better than the consensus forecasted. Earnings for the quarter also exceeded consensus estimates, surging 21% year-over-year to $1.14 per share.

Though both companies posted better-than-expected results, the means were completely different. Advance Auto Parts, which anticipated the acceleration of new car sales expansion, decided to focus on cost-control measures (typically, new car sales strength means less money is spent on maintaining old ones - a negative for the auto parts retailers). Same-store sales declined 1.9% during the quarter, but gross margins increased 90 basis points year-over-year to 49.9%, as the firm noted supply chain and shrink improvement. However, SG&A (overhead) was 80 basis points higher as a percentage of sales at 41.4%, mostly a result of sales deleveraging.

Advance Auto Parts had a tough year, placing much of the blame on unseasonably warm weather throughout the Midwest (though that trend has recently started to reverse itself). Earnings per share for the year were up just 2% year-over-year, and that growth was entirely attributable to share repurchases. Free cash flow was substantially lower than a year ago at $412 million, but we don't think the figure was too bad considering the negative headwinds the firm battled. Looking ahead, Advance Auto Parts provided solid fiscal 2013 guidance, as shown below. The growth implies solid earnings per share gains of 4%-7%, and we think there could be considerable upside if same-store sales growth is better than expected (Image Source: AAP).

O'Reilly, on the other hand, posted great same-store sales growth of 4.2% during the fourth quarter, exceeding internal guidance of 2%-4%. SG&A was up modestly as a percentage of sales, increasing 20 basis points year-over-year to 35.4%. Gross margins did tick up 50 basis points to 50.4%. Overall, this led to 30 basis points of operating margin expansion, which came in at 15% during the fourth quarter.

Looking ahead, the company sees a solid year in store for 2013 (shown below). It expects to add 190 stores, while achieving same-store sales growth of 3%-5%. Still, we are a bit concerned to see expectations for free cash flow fall substantially from the $951 million the firm earned in 2012. Capital spending will be substantially higher in 2013 than it was in 2012, so we don't think the decline implies deteriorating operating performance (Image Source: ORLY).

While we certainly believe performance was strong at both O'Reilly and Advance Auto Parts, we do not believe either makes an attractive investment at this time for the portfolio of our Best Ideas Newsletter. We think the auto parts retailers are facing some serious headwinds as new car sales ramp. As a result, we think a better opportunity lies in shares of Ford (NYSE:F), a company that has performed well but remains incredibly undervalued. We hold shares of Ford in the portfolio of our Best Ideas Newsletter.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: F is included in the portfolio of our Best Ideas Newsletter.