We’re all trying to find winning investments. However, it doesn’t always work out as hoped. At least that’s the case with Advance Auto Parts (AAP 2.87%).
If you put $10,000 in the shares of this aftermarket auto parts retailer five years ago in 2018, then you’d be sitting on a current balance of $3,100 (as of Oct. 6). That equals a terrible return of 69%, which meaningfully lags the 49% gain of the S&P 500.
Investors can boost their knowledge and potentially improve their skills going forward by understanding this company’s recent past and then applying that knowledge to other businesses. Let’s take a closer look.
Disappointing financial performance
One reason for Advance Auto Parts’ poor stock performance is its lack of meaningful expansion. Between 2017 and 2022, revenue increased at a compound annual rate of 3.5%. Same-store sales gains, which might be the single most important metric for any retail-based business, have been underwhelming. This clearly shows that growth has been hard to come by.
That’s alarming, because industry trends point to there being lots of expansion potential. The average age of a vehicle in the U.S. continues to inch higher each year. This should benefit Advance Auto Parts because that means cars are spending more time outside of their original manufacturer’s warranty, requiring the need for aftermarket auto parts for repair or other maintenance. Moreover, the number of these older cars on the road has risen as well, so it’s troubling to see how much this company has struggled.
Improving profitability has also been a challenge. The operating margin in the most recent quarter (the second quarter of 2023, ended July 15) came in at 5%, down from 7.6% in the year-ago period. Management expects this number to drop below 4.3% for the full fiscal year, which represents downgraded guidance. This doesn’t bode well for the company’s earnings power.
Lagging dominant industry peers
With over 5,000 stores located primarily in the U.S., you would think Advance Auto Parts would at least be finding more success, but the way that it has trailed its peers in the industry highlights how much executives have mismanaged the business.
In the last five years, O’Reilly Automotive and AutoZone, which operate basically identical business models as Advance Auto Parts, have seen their share prices soar 165% and 231%, respectively. And it’s very easy to see why.
Both companies have increased revenue, same-store sales, and earnings at strong rates. And they generate lots of free cash flow that has been used by management to aggressively repurchase shares. The result is that both businesses are compounding machines, rewarding investors in a way that Advance Auto Parts can only dream of.
It’s hard to identify a single factor that has caused this, but my guess would be the lack of adequate parts availability. In this industry, customers prioritize getting their cars fixed as quickly as possible to get back to work or running errands or whatever it may be. If Advance Auto Parts doesn’t have the right products in stock, it will continue losing sales to rivals.
Not only that, this business might simply be carrying the wrong type of merchandise. Its cash conversion cycle, which measures how many days it takes a company to turn the cash it spends on inventory into cash collected from sales of products, stands at 78 days. Both O’Reilly and AutoZone, on the other hand, operate with negative cash conversion cycles, meaning they are much better organizations from a cash-management perspective. This might explain Advance Auto Parts’ struggles better than anything else.
A value trap?
As of this writing, shares of Advance Auto Parts are trading at a price-to-earnings (P/E) ratio of under 9. Not only is that significantly cheaper than the S&P 500’s P/E multiple of 19.4, but it also represents a huge discount to both O’Reilly and AutoZone.
Naturally, investors might be eyeing the stock as a potential value play. The hiring of a new CEO, Shane O’Kelly, might give the business the fresh perspective it needs to get things on the right path toward improvement. The goal should be to close the gap with the thriving industry peers.
But I think Advance Auto Parts looks like a classic value trap right now. Until there’s concrete evidence of better financial performance, investors should stay far away from this stock, no matter how cheap the shares look.
Neil Patel and his clients have no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.