382564

Advance Auto Parts (NYSE:AAP) Exceeds Q3 Expectations, Lowers Guidance, Stock Drops 11.1%


Full Report / November 15, 2023

Auto parts and accessories retailer Advance Auto Parts (NYSE:AAP) beat analysts' expectations in Q3 FY2023, with revenue up 2.9% year on year to $2.72 billion. Its full-year revenue guidance of $11.28 billion at the midpoint also came in slightly above analysts' estimates. Turning to EPS, Advance Auto Parts made a GAAP loss of $0.82 per share, down from its profit of $1.84 per share in the same quarter last year.

Advance Auto Parts (AAP) Q3 FY2023 Highlights:

  • Revenue: $2.72 billion vs analyst estimates of $2.67 billion (1.7% beat)
  • EPS: -$0.82 vs analyst estimates of $1.44 (-$2.26 miss)
  • The company slightly lowered its revenue guidance for the full year to $11.28 billion at the midpoint
  • The company significantly lowered its GAAP EPS guidance for the full year to $1.60 at the midpoint ($4.80 prior, reduction includes some one-time expenses)
  • Free Cash Flow of $152.6 million, up 193% from the same quarter last year
  • Gross Margin (GAAP): 36.3%, down from 44.7% in the same quarter last year (one-time "change in estimate for inventory reserves that resulted in a one-time impact of approximately $119 million")
  • Same-Store Sales were up 1.2% year on year (beat vs. expectations of up 0.3% year on year)
  • Store Locations: 4,785 at quarter end, decreasing by 275 over the last 12 months

Founded in Virginia in 1932, Advance Auto Parts (NYSE:AAP) is an auto parts and accessories retailer that sells everything from carburetors to motor oil to car floor mats.

The company serves both do-it-yourself (DIY) customers as well as professional mechanics and auto repair businesses. The company understands that DIY customers may have varying levels of expertise in auto repair, so stores feature automotive expert sales associates who can help you find which brake pads will fit your 2019 Ford Focus, for example.

For the professional mechanic, Advance Auto Parts has a particularly strong selection of commercial products such as heavy-duty truck parts. The company also offers a commercial program with dedicated account managers, customized billing options, and professional-grade tools for rent. A fleet of commercial delivery vehicles thousands strong make sure professional customers get what they need in a timely manner.

Advance Auto Parts stores are typically located in smaller towns and more rural areas compared to auto parts peers, with a strong footprint in the Eastern US. The typical store is roughly 7,500 square feet, with many featuring areas and help desks specifically for professional customers. In addition to its brick-and-mortar stores, Advance Auto Parts also has an e-commerce presence that allows customers to buy products to be shipped to their homes or to buy and pick up at the nearest store to save time.

Auto Parts Retailer

Cars are complex machines that need maintenance and occasional repairs, and auto parts retailers cater to the professional mechanic as well as the do-it-yourself (DIY) fixer. Work on cars may entail replacing fluids, parts, or accessories, and these stores have the parts and accessories or these jobs. While e-commerce competition presents a risk, these stores have a leg up due to the combination of broad and deep selection as well as expertise provided by sales associates. Another change on the horizon could be the increasing penetration of electric vehicles.

Competitors offering auto parts and accessories include AutoZone (NYSE:AZO), O’Reilly Automotive (NASDAQ:ORLY), Genuine Parts (NYSE:GPC), and private company Pep Boys.

Sales Growth

Advance Auto Parts is larger than most consumer retail companies and benefits from economies of scale, giving it an edge over its competitors.

As you can see below, the company's annualized revenue growth rate of 3.9% over the last four years (we compare to 2019 to normalize for COVID-19 impacts) was mediocre as its store footprint remained relatively unchanged, implying that growth was driven by more sales at existing, established stores.

Advance Auto Parts Total Revenue

This quarter, Advance Auto Parts reported decent year-on-year revenue growth of 2.9%, and its $2.72 billion in revenue topped Wall Street's estimates by 1.7%. Looking ahead, analysts expect sales to grow 1.2% over the next 12 months.

Number of Stores

When a retailer like Advance Auto Parts keeps its store footprint steady, it usually means that demand is stable and it's focused on improving operational efficiency to increase profitability. Since last year, Advance Auto Parts's store count shrank by 275 locations, or 5.4%, to 4,785 total retail locations in the most recently reported quarter.

Advance Auto Parts Operating Retail Locations

Taking a step back, the company has kept its physical footprint more or less flat over the last two years while other consumer retail businesses have opted for growth. A flat store base means that revenue growth must come from increased e-commerce sales or higher foot traffic and sales per customer at existing stores.

Same-Store Sales

A company's same-store sales growth shows the year-on-year change in sales for its brick-and-mortar stores that have been open for at least a year, give or take, and e-commerce platform. This is a key performance indicator for retailers because it measures organic growth and demand.

Advance Auto Parts's demand within its existing stores has been relatively stable over the last eight quarters but fallen behind the broader consumer retail sector. On average, the company's same-store sales have grown by 1.3% year on year. Given its flat store count over the same period, this performance stems from increased foot traffic at existing stores or higher e-commerce sales as the company shifts demand from in-store to online.

Advance Auto Parts Year On Year Same Store Sales Growth

In the latest quarter, Advance Auto Parts's same-store sales rose 1.2% year on year. This growth was a well-appreciated turnaround from the 0.7% year-on-year decline it posted 12 months ago, showing the business is regaining momentum.

Gross Margin & Pricing Power

We prefer higher gross margins because they not only make it easier to generate more operating profits but also indicate product differentiation, negotiating leverage, and pricing power.

Advance Auto Parts has great unit economics for a retailer, giving it ample room to invest in areas such as marketing and talent to grow its brand. As you can see below, it's averaged an impressive 43.1% gross margin over the last eight quarters. This means the company makes $0.43 for every $1 in revenue before accounting for its operating expenses. Advance Auto Parts Gross Margin (GAAP)

Advance Auto Parts produced a 36.3% gross profit margin in Q3, marking a 8.4 percentage point decrease from 44.7% in the same quarter last year. Although the company could've performed better, we care more about its long-term trends rather than just one quarter. Additionally, a retailer's gross margin can often change due to factors outside its control, such as product discounting and dynamic input costs (think distribution and freight expenses to move goods). We'll keep a close eye on this.

Operating Margin

Operating margin is a key profitability metric for retailers because it accounts for all expenses keeping the lights on, including wages, rent, advertising, and other administrative costs.

This quarter, Advance Auto Parts generated an operating profit margin of negative 1.6%, down 8.6 percentage points year on year. We can infer Advance Auto Parts was less efficient with its expenses or had lower leverage on its fixed costs because its operating margin decreased more than its gross margin.

Advance Auto Parts Operating Margin (GAAP)

Zooming out, Advance Auto Parts was profitable over the last eight quarters but held back by its large expense base. It's demonstrated subpar profitability for a consumer retail business, producing an average operating margin of 4.7%. On top of that, Advance Auto Parts's margin has declined, on average, by 3.5 percentage points year on year. This shows the company is heading in the wrong direction, and investors were likely hoping for better results.

EPS

These days, some companies issue new shares like there's no tomorrow. That's why we like to track earnings per share (EPS) because it accounts for shareholder dilution and share buybacks.

In Q3, Advance Auto Parts reported EPS at negative $0.82, down from $1.84 in the same quarter a year ago. This print unfortunately missed Wall Street's estimates, but we care more about long-term EPS growth rather than short-term movements.

Advance Auto Parts EPS (GAAP)

Between FY2019 and FY2023, Advance Auto Parts's adjusted diluted EPS dropped 62.8%, translating into 15.7% average annual declines. In a mature sector such as consumer retail, we tend to steer our readers away from companies with multiple years of falling EPS. If there's no earnings growth, it's difficult to build confidence in a business's underlying fundamentals, leaving a low margin of safety around the company's valuation (making the stock susceptible to large downward swings).

Wall Street expects Advance Auto Parts to continue performing poorly over the next 12 months, with analysts projecting an average 68.7% year-on-year decline in EPS.

Cash Is King

If you've followed StockStory for a while, you know that we emphasize free cash flow. Why, you ask? We believe in the end, cash is king, and you can't use accounting profits to pay the bills.

Advance Auto Parts's free cash flow came in at $152.6 million in Q3, up 193% year on year. This result represents a 5.6% margin.

Advance Auto Parts Free Cash Flow Margin

Over the last eight quarters, Advance Auto Parts has shown mediocre cash profitability, putting it in a pinch as it gives the company limited opportunities to reinvest, pay down debt, or return capital to shareholders. Its free cash flow margin has averaged 1.8%, subpar for a consumer retail business. Furthermore, its margin has averaged year-on-year declines of 1.7 percentage points.

Return on Invested Capital (ROIC)

We like to track a company's long-term return on invested capital (ROIC) in addition to its recent results because it gives a big-picture view of a business's past performance. It also sheds light on its management team's decision-making prowess and is a helpful tool for benchmarking against peers.

Advance Auto Parts's subpar returns on capital may signal a need for future capital raising or borrowing to fund growth. Its five-year average ROIC is 8.8%, somewhat low compared to the best retail companies that consistently pump out 25%+ returns.

Key Takeaways from Advance Auto Parts's Q3 Results

Sporting a market capitalization of $3.45 billion, Advance Auto Parts is among smaller companies, but its more than $317.5 million in cash on hand and positive free cash flow over the last 12 months puts it in an attractive position to invest in growth.

It was good to see Advance Auto Parts beat analysts' revenue expectations this quarter, aided by a same-store sales beat. Beyond that, it was a complicated and worrisome quarter. Gross margin declined meaningfully year on year (partly due to a one-time inventory charge) and EPS missed. While full year revenue guidance was only slightly lowered, EPS guidance was meaningfully lowered, with management highlighting "continued pressure in Q4 from higher product costs that we do not expect to offset with price. We are taking significant steps to improve our cost structure and remain focused on returning the business to profitable growth.” Overall, this was a mediocre quarter for Advance Auto Parts. The company is down 11.1% on the results and currently trades at $51.97 per share.

Is Now The Time?

Advance Auto Parts may have had a tough quarter, but investors should also consider its valuation and business qualities when assessing the investment opportunity.

We cheer for all companies serving consumers, but in the case of Advance Auto Parts, we'll be cheering from the sidelines. Its revenue growth has been mediocre over the last four years, and analysts expect growth to deteriorate from here. And while its gross margins are a strong starting point for the overall profitability of the business, the downside is that its mediocre same-store sales performance has been a headwind. On top of that, its relatively low ROIC suggests it has struggled to grow profits historically.

Advance Auto Parts's price-to-earnings ratio based on the next 12 months is 10.8x. While we think the price is reasonable and there are some things to like about Advance Auto Parts, we think there are better opportunities elsewhere in the market right now.

To get the best start with StockStory, check out our most recent stock picks and then sign up to our earnings alerts by adding companies to your watchlist here. We typically have the quarterly earnings results analyzed within seconds of the data being released, and especially for companies reporting pre-market, this often gives investors the chance to react to the results before the market has fully absorbed the information.