Advance Auto Parts: Current Environment Spark Long-Term Growth

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Thesis

I believe sustained expansion for the aftermarket auto components field is at the beginning of a strong cycle pushed by buyer and pricing trends. With the common age of automobiles on the highway at all-time highs, automobile price ranges at document highs, and whole car or truck miles traveled again at historic amounts use and tear on cars and the likely need to have for areas & repairs may be elevated transferring forward.

Along with probable market-extensive demand, I imagine Advance Automobile Areas (NYSE:AAP) is at a profitability inflection position. Owing to earlier running inefficiencies, AAP lags opponents in phrases of margins. With new acquisitions of strong makes like DieHard and Carquest, AAP is concentrated on escalating private-label penetration which in flip may well assistance gross margins. With administration targeted on expanding distribution & store community capabilities as perfectly as perks like identical-day shipping for Do it yourself customers, they could carry on to drive development in equally experienced and Do-it-yourself segments.

With prospective macro and idiosyncratic tailwinds on the horizon, I imagine AAP has a stable very long-phrase expansion runway. Few that with management’s capacity to return cash to shareholders and what I believe that is presently an appealing valuation, AAP could generate alpha prolonged-phrase.

Track record

Sophisticated Auto Components is a leader in aftermarket automotive elements in North The united states.

Prospects

  • Skilled Installers: Mechanics, auto stores, auto dealers (58% of profits)
  • Person Prospects: Do-it-yourselfers “Diy”
  • Independently Owned Operators

Items

AAP Products

AAP 10-k

Trade Names

  • Progress Auto Areas
  • Autopart Intercontinental
  • Carquest
  • Worldpac
  • www.AdvanceAutoParts.com

Destinations (as of January 31, 2022)

  • 4,706 whole suppliers
  • 266 branches
  • 52 distribution centers
  • e-commerce site

Suppliers

  • Procured merchandise from 1,200 sellers in 2021 which include models like Bosch, Castrol (BP), and Mobil 1 (XOM)
  • Private manufacturers include things like Autocraft, Autopart Intercontinental, Driveworks, Hard One particular, Wearever, Carquest, and DieHard

Thesis Support

Sector Set up

Soon after declining by -13.4% year-about-calendar year in February ’21, overall vehicle miles traveled have recovered to all-time highs as of May well of this calendar year:

Total Miles Drive in the U.S.

FRED

As additional miles are pushed, utilised cars and trucks also keep on to increase as a share full of automobile product sales:

New vs Used % of Total Vehicle Sales

BTS

Much more applied vehicle sales have led to the common age of automobiles on the road escalating to 12.2 many years, the greatest stage given that the S&P (SPGI) began recording this metric.

As cars have gotten older, they have also gotten additional expensive, specifically in the past two decades:

CPI New and Used Vehicles

FRED

Automobile price ranges are also growing as the 10-calendar year Treasury yield recently eclipsed 340 basis points, a amount not witnessed in the very last ten years. Merely place, climbing funding costs coinciding with growing costs suggests affordability for autos may well fall substantially.

Due to the fact in general motor vehicle affordability might drop, the regular age of vehicles on the street is at record degrees, and auto miles pushed are nonetheless at all-time highs I believe that vehicle put on & tear and the need for areas & maintenance will increase.

Idiosyncratic Catalysts

Probable over-all development and margin enlargement catalysts for AAP include things like the growth of private label items, Do it yourself market enlargement, and provide chain efficiency.

By growing personal label penetration (~40% of full gross sales currently), AAP might be able to maximize gross margins since they will not spend vendor incentives for their individual proprietary solutions. By also marketing their proprietary brands exclusively at AAP outlets, products quality may well drive extra Do-it-yourself prospects to their outlets (and web-site) and build strong associations with expert buyers.

I believe that AAP is perfectly-positioned to excel in the Do-it-yourself section by providing client incentives like selling price match ensures, the Progress Very same Day suite (no cost curbside decide on-up or property shipping in <3 hours), and the Speed Perks loyalty program. Incentivizing DIY consumers may build loyalty and balance out the current disaggregated revenue mix. With a plan to open up an additional 125-150 new stores in 2022 and plans to continue growth through acquisitions loyalty & brand recognition may help sustain positive returns on these new store/brand investments.

With significant investment in its supply chain following the urge to streamline supply chains after the COVID disruptions, I believe AAP is set up to experience a more efficient distribution network in the future. As these investments come to fruition, AAP may be able to keep stronger inventory control which may lead to better professional installer relations/loyalty. With better supply chain control and potential network effects with new acquisitions, there is ample room for margin expansion in my opinion.

Cash Returns to Shareholders

Currently, AAP’s dividend is yielding 3.27% after increasing its quarterly dividend per share from $0.25 to $1.00 last year. In Q1 this year, management raised the dividend to $1.50 per quarter showing an LTM payout ratio of ~50%. The board also authorized an additional $1 billion share repurchase program in February of this year on top of the $1 billion announced in April 2021. In all of 2021, AAP repurchased $886.7 million of its common stock, retiring 4.6 million shares.

Between share repurchases and dividend payments, AAP returned $403 million to shareholders in Q1. If AAP keeps that cash return consistent for the next twelve months, that equates to 15% of its current market cap [in one year].

Financials

Earnings Forecasts

Earnings Estimates

Created By Author

Discounted Cash Flow Analysis

Based on my 30-year cash flow projections, 10-year terminal multiple, and my estimated weighted average cost of capital [WACC] of 5.31% there is a 112% upside for AAP. Below are my discounted cash flow [DCF] analysis inputs and results:

DCF Inputs

Created By Author

DCF Results

Created By Author

DCF Sensitivity Table

Created By Author

Multiple Comparisons

Currently, AAP trades at a 5x NTM P/E discount to the peer average between AutoZone (AZO), O’Reilly Automotive (ORLY), and Genuine Parts Company (GPC). With margins and returns on invested capital also well below the comp. average, I believe the discount is currently justified. With the discount to peers and potential roadmap for growth and margin expansion, I believe there are a lot of opportunities for AAP to become more in line with the industry in terms of valuation multiples:

ROIC

Created By Author

Given where AAP currently trades in terms of relative valuation, I also believe upside currently outweighs further downside purely based on its P/E:

AAP NTM P/E

Koyfin

Risks

Narrow Moat

Outside of competitive advantages like inventory efficiency and customer loyalty, I believe AAP has no special positioning in the aftermarket auto parts industry. Competitors like AutoZone and O’Reilly all operate very similar business models fighting for virtually the same customers. As the industry shifts further online, AAP and other aftermarket auto dealers also have to compete directly against Amazon (AMZN).

Because of all these competitive forces, I believe AAP has a narrow moat and limited pricing power which is a key risk that may keep its growth and multiple suppressed.

A mitigant to this risk is customer loyalty which can be derived from a quality proprietary product suite and efficient inventory control in my opinion.

Electric Vehicles

Technological advances in auto manufacturing especially in the EV space could hurt AAP’s current business model long term. With engine maintenance accounting for 12% of revenue last year and parts and batteries accounting for 66%, wide adoption of EVs could hinder demand in both of these segments.

A potential mitigant to this risk is an adaptive business model and growth in other segments like ‘accessories and chemicals.’

Summary

I believe the aftermarket auto parts industry has strong long-term tailwinds that may support overall demand. I also believe AAP is positioned to expand margins given its supply chain investments and new programs incentivized to build customer loyalty. Combine potential margin expansion, industry tailwinds, and acquisition/new store growth AAP could deliver strong returns for shareholders at current valuation levels.

With the board and management seemingly focused on returning cash to shareholders, that could also be a strong catalyst for price appreciation given its current market capitalization.

Katherine T. Burrows

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