After third-quarter earnings that leave it ahead of our 2018 revenue target, we anticipate raising our $165 per share valuation for narrow-moat Advance (AAP) by a high-single-digit percentage. The short-term forecast boost should leave our longer-term expectations (mid-single-digit average top-line growth, adjusted operating margin expansion to the low double digits by fiscal 2022) largely intact; we have long expected improving results as part availability and efficiency initiatives take hold.
Year-to-date sales rose 2% against 53 basis points of adjusted operating margin expansion (to 8.3%), fueled by improving industry conditions, better execution (partly enabled by cross-banner availability), and improved inventory efficiency. Management raised its 2018 guidance to $9.55 billion to $9.6 billion in sales (from $9.3 billion to $9.5 billion) and a 7.6% to 7.8% adjusted operating margin (from 7.5% to 7.8%), versus our $9.4 billion and 7.7% respective pre-earnings estimates.
Management believes 60% to 70% of its roughly 12-point 2017 adjusted operating margin gap versus its rivals is addressable long term, suggesting about 7-8 points of potential improvement into the low-teens. We are somewhat more conservative, assuming Advance exceeds 11% by the end of fiscal 2022. While we view the turnaround positively, we counsel some caution as the associated upheaval should leave Advance more vulnerable to industry conditions or execution missteps than its stabilized peers. Still, the differential suggests upside if tailwinds persist. Its recent agreement with Walmart to offer an assortment of parts on the retail juggernaut's website could help accelerate progress, with Advance capitalizing on its partner's prodigious online traffic using a targeted assortment. While we still believe scaled parts retailers like Advance are relatively well insulated from digital threats, we expect the initiative (which will see Advance retain pricing control over its items) to prove additive.
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Zain Akbari, CFA does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.