The U.S. has approximately 284 million vehicles in operation currently, with the average age of cars and light trucks rising again to a new record of 12.5 years, up by more than three months over the same period in 2022 according to the latest analysis from S&P Global Mobility. In addition, the ongoing rise of pickup trucks and SUVs means the number of passenger cars on the road will fall below 100 million for the first time since 1978. This bodes well for aftermarket auto parts providers like Advance Auto Parts Inc. (AAP, Financial).
The company is a leading automotive aftermarket parts provider that serves both professional mechanics and do-it-yourself customers. As of April 22, it operated 4,778 stores and 318 Worldpac branches mostly within the U.S., but with additional locations in Canada, Puerto Rico and the Virgin Islands. The company also served 1,315 independently owned Carquest branded stores in these locations in addition to Mexico and certain Caribbean islands.
Founded in 1932, the company currently has a market capitalization of $3.80 billion.
Financial review
On May 31, the company reported disappointing financial results that caused the stock to decline 35% in one day. First-quarter sales increased 1.30% to $3.40 billion, driven by new store openings as same-store sales declined 0.40%.
The gross profit decreased 2.40% to $1.50 billion, which was a gross margin of 43%, a decrease from 44.60% in the prior-year period. The company was not able to raise prices enough to offset inflationary products costs.
Selling, general and administrative expenses were $1.4 billion, which was 40.40% of sales compared with 38.60% in the year-ago quarter. This increase was primarily driven by labor inflation and higher benefit-related expenses as well as normal costs associated with new store openings. The SG&A was partially offset by a decrease in startup costs related to the company's planned California expansion.
Operating income was $90 million, which was an operating margin of 2.60%, a stunning reversal from 6% in the first quarter of 2022. Labor inflation continues to significantly hamper operating margins.
Operating cash flow and free cash were negatively affected by these poor results. Net cash used in operating activities was $378.90 million in the first quarter compared to $54.90 million used in the prior-year period. The increased use of cash was primarily driven by lower net income and an increase in working capital, primarily in accounts payable. Free cash flow in the first quarter of 2023 was an outflow of $468.90 million compared with an outflow of $169.80 million a year ago.
As of April 22, the company carried cash and equivalents of $226.50 million and total long-term debt of $1.80 billion. Working capital was $1.2 billion.
In a statement, CEO Thomas Greco said,“We remain focused on improving inventory availability while sustaining competitive price targets to improve topline sales. We expect the competitive dynamics we faced in the first quarter to continue, resulting in a shortfall to our 2023 expectations.”
Valuation
During the last earnings release, the company lowered its annual guidance to a comp sales decline between 0% and -1% and earnings per share in the range of $6 to $6.50. This was a significant reduction from earlier guidance of earnings in the range of $10.20 to $11.20.
That puts the stock selling at approximately 10 times annual earnings and a forward enterprise value-Ebitda ratio of roughly 9. The historical price-earnings ratio of the company has typically been in the high-teens range.
The GuruFocus discounted cash flow calculator creates a value of $88 when using an earnings starting point of $6.50 and long-term growth of only 6%. The discount rate used in the calculation is 10%.
The company recently cut its dividend from an annualized rate of $6 to only $1. The current dividend yield is approximately 1.53%.
Further, Chief Financial Officer Jeff Shepherd said, "Our board of directors made the decision to reduce our quarterly cash dividend to provide enhanced financial flexibility. We are committed to improving our operational performance and driving increased profitability."
Guru trades
Gurus who have purchased Advance Auto Parts stock recently include First Eagle Investment (Trades, Portfolio) and Ray Dalio (Trades, Portfolio)'s Bridgewater Associates. Investors who have reduced or sold out of their positions include Diamond Hill Capital (Trades, Portfolio) and Paul Tudor Jones (Trades, Portfolio).
Summary
Advance Auto Parts operates in a recession-resistant category and has the potential to continue opening units, both domestic and international. An improving free cash profile should allow the company to continue to buy back shares and improve earnings per share growth.
After the recent stock swoon and the current low valuation levels, the stock could represent a potential opportunity for long-term value investors. Even a modest recovery in margins with some level of multiple increases should provide substantial upside for the stock. In addition, it is possible the dividend could steadily increase to historical levels once margins and free cash flow improve.
