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Stock Strategist

Advance Auto Parts' Potential Overshadowed by Difficult Integration

The company still should benefit from industry trends, and we think its shares are undervalued.

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Integrating the General Parts acquisition has been more challenging than expected for  Advance Auto Parts (AAP), contributing to comparable-store sales that held steady in 2015 despite favorable industry dynamics. Nonetheless, we recently increased our fair value estimate to reflect our expectations for long-term margin and revenue growth after the integration is finished.

While we do not expect Advance to hit its 12.0% 2016 operating margin target, we have a favorable view of its longer-term opportunities to gain efficiencies and close the performance gap with its peers. Although much of the company's lower profitability can be attributed to its reliance on independently owned stores, greater proportion of rented (rather than owned) locations than its peers, and higher proportion of commercial sales, we see ample margin-enhancing opportunities to optimize the distribution network, secure more favorable inventory financing, and drive private-label penetration. We also expect Advance to enjoy the same industry tailwinds as its peers, with structural changes that favor larger-scale chains due to their ability to leverage inventories and distribution networks across a dense store network and extensive sales base.

Zain Akbari does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.