An Undervalued Company Deepening Its Competitive Advantages

Although narrow-moat Advance Auto Parts has long lagged its peers in profitability, we believe the company's ongoing turnaround effort can unlock improved performance as it capitalizes on its balanced professional and do-it-yourself segment exposures. The retailer is poised to rebuild share in a market that should see consolidation behind large national retailers that can leverage a broad distribution network to efficiently provide a high standard of service.

We assign Advance a narrow economic moat rating due to its brand-intangible assets and the cost advantages afforded by its national presence. Advance participates in an industry where differentiated service levels can lead to the formation of strong brands. Demand is price-inelastic, with parts availability, convenience, and in-store services carrying significant weight. Because these consumer benefits are costly to deliver, large retailers such as Advance are at an advantage, as they can spread service costs and inventory holding expenses over a large sales base. Brands are especially significant on the commercial side of the industry, where clients tend to be retailer-loyal, preferring to stay with trusted partners as any cost differentials can largely be passed on to vehicle operators.

Our moat trend rating for Advance is positive. While the industry's move toward greater parts availability levels carries some expense, we believe it deepens Advance's competitive advantages by creating added brand differentiation versus smaller regional peers while capitalizing on an infrastructure that only the largest retailers have in place. Because the auto parts industry is highly fragmented, differentiation from local and regional incumbents offers Advance a significant market share growth opportunity and a chance to leverage inventory investments over a larger sales base, enhancing returns over time.

Trading at more than a 25% discount to our fair value estimate, shares of Advance are a compelling opportunity today.