Advance Auto Parts Earnings: Disappointing Period but Not the Disaster Suggested by Stock Plunge

Advance Auto Parts Stock at a Glance

• Fair Value Estimate: $191
• Morningstar Rating: 3 stars
• Morningstar Economic Moat Rating: Narrow
• Morningstar Uncertainty Rating: Medium

Advance Auto Parts Earnings Update

Our $191 fair value estimate for narrow-moat Advance Auto Parts AAP should fall by a high-single-digit percentage in the wake of disappointing first-quarter results and a per-share dividend cut to $0.25 per quarter from $1.50. However, we do not believe the results are as much of a disaster as the shares’ 30%-plus postearnings plunge might suggest.

We see the challenges Advance faced in the period (most notably, larger-than-expected price cuts in the professional segment) as idiosyncratic, with the sector’s favorable traits intact. While it will take time to right the ship, we believe our long-term forecast for Advance (mid-single-digit top-line growth and low-double-digit operating margins over the next decade) is sufficiently conservative.

Comparable sales fell 0.4%, leading to a 2.6% operating margin that slid from 6.0% due mostly to cost deleverage. Management cited competitive pricing action in the professional segment as the main culprit, remarks at odds with the comparatively placid view of the industry offered by narrow-moat peers O’Reilly, AutoZone, and Genuine Parts (the four constitute about 30% of the fragmented professional segment).

We attribute the difference to Advance’s part availability and service inferiority, despite progress in fill rates and delivery performance. While the other firms have, to varying extents, sharpened pricing in the segment recently on certain traffic-driving items, they each make no apology for pricing at a premium to subscale and distributor rivals, justified by their superior service.

With Advance still unable to provide service levels on par with the other scaled firms, we believe its offerings are more directly comparable with the far more price-competitive smaller retailers in its markets. As a result, we see little reason to doubt scaled retailers’ longstanding focus on service levels as opposed to price points, which bodes well for Advance once category management and supply chain work pay off.