*All data are as of the close of Friday, December 5, 2014. Emphasis is on company fundamentals and financial data rather than commentary.
To get a better idea of how the Auto Parts Stores industry behaves, we'll need to dismantle it part by part and examine it across different periods of the overall market's performance. I guess that makes us stock mechanics of sorts.
The first thing investors need to consider is the difference between the Auto Parts Stores industry and the Auto Parts industry, like a mechanic differentiating what make and model he or she is working on.
Very simply put, the Auto Parts industry belongs to the Consumer Goods sector and is comprised of companies that manufacture auto parts, the largest 3 U.S. companies on which I have already run a comparison.
Whereas the Auto Parts Stores industry and subject of this comparison belongs to the Services sector and is comprised of retail companies that sell auto parts to auto manufacturers, dealership service centers, mechanics shops, and individual consumers.
The distinction between the two industries is very important to make when analyzing their performance as each delivered strikingly different results during the last economic downturn and during the recovery since.
The two industries' differing performances revolve around vehicle sales nationwide. As graphed below, after years of averaging some 17 million new vehicles sold annually [orange], the number plunged by 47% to a low of 9 million in sales annually over just two years from the start of 2007 until the early part of 2009 [red], after which sales have slowly returned to their normal 17 million annual average currently (green).
Naturally, during that plunge in new vehicles sales, we would expect the Auto Parts manufacturing industry to slump, as graphed below.
During the worst part of the sell-off from mid July 2007 until early March 2009, where the broader market S&P 500 Index [black] fell 56% and the SPDR Consumer Discretionary Sector ETF (NYSE: XLY) [blue] fell 60%, the three largest U.S. Auto Parts manufacturers - Johnson Controls, Inc. (NYSE: JCI) [beige], BorgWarner Inc. (NYSE: BWA) [purple], and TRW Automotive Holdings Corp. (NYSE: TRW) [orange] - fell 77%, 68%, and 96%, respectively.
Yet as graphed below, the three largest Auto Parts Stores companies - O'Reilly Automotive, Inc. (NASDAQ: ORLY) [beige], AutoZone, Inc. (NYSE: AZO) [purple], and Advance Auto Parts, Inc. (NYSE: AAP) [orange] - behaved entirely differently, changing by -9%, +10%, and -9%, respectively. That's right, just single-digit losses and even a double-digit gain - all while the majority of the market, including the auto parts manufacturers, were sinking hard.
How can we explain the two auto parts industries' disparities? The best explanation I can come up with is that during the worst of the economic crisis, consumers were strapped for cash such that rather than spending a lot on purchasing new vehicles, they opted to spend less on fixing up their existing vehicles.
Hence, with fewer new vehicles being sold, there was less demand by auto factories for new auto parts. But there was increased demand for parts already in stock at the retailers - who also sell used parts - to keep existing vehicles running a little longer.
The lesson here, of course, is that the Auto Parts Stores industry, while still being considered a volatile Consumer Discretionary, is generally a little more defensive - sometimes a lot more so - than the Auto Parts manufacturers.
The only downside to this, however, is that the Auto Parts Stores' more defensive posture hurts them during bull runs, as we have been witnessing since the start of the recovery in March of 2009, as graphed below.
Since the bull run began in early '09, where the S&P has gained some 205% and the XLY has gained 345%, all three of the largest U.S. Auto Parts manufacturers have beaten them both, rising 420%, 650%, and 6,700%, respectively (that's right, 67 times)!
Meanwhile, only one of the three largest Auto Parts Stores companies, O'Reilly, has managed to outperform both the market and the sector while the other two, AutoZone and Advance, have landed in between the two benchmarks, each rising 490%, 290%, and 325%, respectively, as graphed below.
The explanation for this, of course, is that as vehicle sales and production have increased over the years as depicted in the first graph, the demand for new parts from the parts manufacturers by the auto producers has trumped the demand for parts from retailers by consumers. Plus the auto parts manufacturers had already fallen more to begin with and were starting from drastically oversold levels.
Looking forward, the Auto Parts Stores industry as a whole looks set to continue assembling quite a spurt of earnings growth compared to the broader market as tabled below where green indicates outperformance while yellow denotes underperformance.
Over the next two quarters, the industry's earnings are expected to grow at 1.98 to 3.27 times the S&P's average growth rate, with 2015 growing at a more modest 2.02 times before slowing to a more sustainable 1.63 times rate annually over the next five years.
Zooming in a little closer, the three largest companies in the industry are expected to split perform with a little surprise, as tabled below.
Where O'Reilly is still expected to outgrow AutoZone clear across the calendar, Advance looks poised to advance its earnings growth far faster than the once dominant O'Reilly.
Versus the broader market S&P, while all three are seen underperforming next quarter, from 2015 onward, they are set to piece together growth rates ranging from 1.23 to 1.90 times the market's average.
Yet there is more than earnings growth to consider when sizing up a company as a potential investment. How do the three compare against one another in other metrics, and which makes the best investment?
Let's answer that by comparing their company fundamentals using the following format: a) financial comparisons, b) estimates and analyst recommendations, and c) rankings with accompanying data table. As we compare each metric, the best performing company will be shaded green while the worst performing will be shaded yellow, which will later be tallied for the final ranking.
A) Financial Comparisons
• Market Capitalization: While company size does not necessarily imply an advantage and is thus not ranked, it is important as a denominator against which other financial data will be compared for ranking.
• Growth: Since revenues and expenses can vary greatly from one season to another, growth is measured on a year-over-year quarterly basis, where Q1 of this year is compared to Q1 of the previous year, for example.
In the most recently reported quarter, Advance generated the greatest revenue and earnings growth year-over-year while AutoZone reported the least, even revenue shrinkage.
• Profitability: A company's margins are important in determining how much profit the company generates from its sales. Operating margin indicates the percentage earned after operating costs, such as labor, materials, and overhead. Profit margin indicates the profit left over after operating costs plus all other costs, including debt, interest, taxes, and depreciation.
Of our three contestants, AutoZone operated with the widest profit and operating margins while Advance contended with the narrowest.
• Management Effectiveness: Shareholders are keenly interested in management's ability to do more with what has been given to it. Management's effectiveness is measured by the returns generated from the assets under its control and from the equity invested into the company by shareholders.
For their managerial performance, AutoZone's management team delivered the greatest returns on assets where Advance's team delivered the least.
Since AutoZone's return on equity is not available, the metric does not factor in the comparison, though it is worth noting that both O'Reilly and Advance generated outstanding returns on equity.
• Earnings Per Share: Of all the metrics measuring a company's income, earnings per share is probably the most meaningful to shareholders as this represents the value that the company is adding to each share outstanding. Since the number of shares outstanding varies from company to company, I prefer to convert EPS into a percentage of the current stock price to better determine where an investment could gain the most value.
Of the three companies here compared, AutoZone provides common stockholders with the greatest diluted earnings per share gain as a percentage of its current share price while O'Reilly's DEPS over current stock price is the lowest.
• Share Price Value: Even if a company outperforms its peers on all the above metrics, however, investors may still shy away from its stock if its price is already trading too high. This is where the stock price relative to forward earnings and company book value comes under scrutiny, as well as the stock price relative to earnings relative to earnings growth, known as the PEG ratio. Lower ratios indicate the stock price is currently trading at a cheaper price than its peers, and might thus be a bargain.
Among our three combatants, AutoZone's stock is cheapest relative to forward earnings, where Advance's stock is cheapest relative to 5-year PEG. At the overpriced end of the scale, O'Reilly is the most overvalued relative to earnings and PEG.
Since AutoZone's price to company book value is not available, the metric does not factor in the comparison.
B) Estimates and Analyst Recommendations
Of course, no matter how skilled we perceive ourselves to be at gauging a stock's prospects as an investment, we'd be wise to at least consider what professional analysts and the companies themselves are projecting - including estimated future earnings per share and the growth rate of those earnings, stock price targets, and buy/sell recommendations.
• Earnings Estimates: To properly compare estimated future earnings per share across multiple companies, we would need to convert them into a percentage of their stocks' current prices.
Of our three specimens, AutoZone offers the highest percentages of earnings over current stock price for the current quarter and 2015, where Advance offers it for the next quarter. At the low end of the spectrum, O'Reilly offers the least percentages throughout.
• Earnings Growth: For long-term investors, this metric is one of the most important to consider, as it denotes the percentage by which earnings are expected to grow or shrink as compared to earnings from corresponding periods a year prior.
For earnings growth, Advance offers the greatest earnings growth in the current quarter and over the next five years while O'Reilly offers it next quarter and in 2015. At the low growth end of the scale, AutoZone offers the slowest growth overall.
• Price Targets: Like earnings estimates above, a company's stock price targets must also be converted into a percentage of its current price to properly compare multiple companies.
For their high, mean, and low price targets over the coming 12 months, analysts believe AutoZone's stock offers the least upside potential and greatest downside risk while Advance's stock offers the greatest upside and O'Reilly's offers the least downside.
• Buy/Sell Recommendations: After all is said and done, perhaps the one gauge that sums it all up is analyst recommendations. These have been converted into the percentage of analysts recommending each level. However, I factor only the strong buy and buy recommendations into the ranking. Hold, underperform and sell recommendations are not ranked since they are determined after determining the winners of the strong buy and buy categories and would only be negating those winners of their duly earned titles.
Of our three contenders, O'Reilly is best recommended with 7 strong buys and 7 buys, representing a combined 53.85% of its 26 analysts, followed by Advance with 6 strong buy and 7 buy ratings, representing 50% of its 26 analysts, and lastly by AutoZone with 4 strong buy and 5 buy recommendations, representing 33.33% of its 27 analysts.
Having crunched all the numbers and compared all the projections, the time has come to tally up the wins and losses and rank our three competitors against one another.
In the table below, you will find all of the data considered above plus a few others not reviewed. Here is where using a company's market cap as a denominator comes into play, as much of the data in the table has been converted into a percentage of market cap for a fair comparison.
The first and last placed companies are shaded. We then add together each company's finishes to determine its overall ranking, with first place finishes counting as merits while last place finishes count as demerits.
And the winner is… Advance finishing far in advance, outperforming in 13 metrics and underperforming in 5 for a net score of +8, followed far behind by O'Reilly, outperforming in 7 metrics and underperforming in 10 for a net score of -3, with AutoZone out of the zone, outperforming in 10 metrics and underperforming in 15 for a net score of -5.
Where the Auto Parts Stores industry is expected to outperform the S&P broader market significantly this and next quarters, in 2015, and meaningfully beyond, all of the three largest companies in the space are expected to lag the broader market in earnings growth next quarter, before mounting a stellar outperformance in 2015 and beyond.
Yet after taking all company fundamentals into account, Advance Auto Parts pieces together the sturdiest financials, given its lowest stock price to 5-year PEG, highest current ratio, highest revenue over market cap, highest trailing revenue and earnings growth, highest future earnings over current stock price for next quarter, highest earnings growth overall, highest dividend, best high and mean price targets, and most analyst buy recommendations - decisively winning the Auto Parts Stores industry competition.