Pep Boys No Longer Leaking Oil, But Stock's Expensive

TheStreet.com

NEW YORK (TheStreet) -- The last time we discussed the state of retailer/auto services giant Pep Boys , I raised concerns about what appeared to be leaks in the company's operating model.

Although management had made decent operational progress, the company was still struggling with same-store sales (comps), while margins were compressing. Pep Boys had no answer to the moves made by much nimbler rivals such as Advance Auto Parts and AutoZone . Making matters worse was the fact that Wal-Mart was beginning to encroach on both Pep Boys' merchandise business and its services revenue.

Today, however, after a solid fourth-quarter earnings report (in April) Pep Boys has an extra "pep in its step." Since the April release, the stock has been up by as much as 8%. With the company due to report fiscal first-quarter earnings on Tuesday, investors are looking for more gains. But the stock is not cheap -- not at a P/E of 53, which is more than 3-times that of Auto Zone and Advance Auto Parts.

Average estimates predicts revenue of $532.8 million, which would represents growth of just 1.6%. This projection seems conservative to me, though, especially since the company is coming off a strong quarter where revenue grew better than 5%.

While it's true there are still concerns regarding the impact of payroll tax increases and the slow payments in income tax refunds, which has cause consumers to postpone vehicle repairs, I don't believe that this reason can be used indefinitely.

Besides, although Advance Auto Parts and Auto Zone just posted unassuming relative results, their sales figures, which includes revenue growth of 3% and 4.5%, respectively, suggests a better-than-expected start to the spring selling season.


Accordingly, I would expect Pep Boys to post sales results that beat Street estimates by at least 1.5% ($540.8 million). On the bottom line, however, the Street is looking for 9 cents per share in earnings, or year-over-year growth of 125%. That number seems aggressive, especially since Pep Boys missed EPS estimates last year by 6 cents.

Given recent improvements last quarter in both gross margin and operating margin, which advanced by 30 basis points and 10 basis points, respectively, I'm not expecting a disaster. But a bottom line miss wouldn't be a surprise, either. But investors shouldn't make the mistake and be so focused on the bottom line here -- not to the extent that it "makes or breaks" Pep Boys' momentum.

Remember, this company is still in the midst of bringing operational efficiency to its model. I'm saying to let the company off the hook for missing its targets. But more pressing issues must be addressed, including the fact that Pep Boys stores are often considered to be in "undesirable locations." These and other factors have hurt sales.

I'm also curious to hear what the company says about the progress it is making to bring efficiency in space utilization. In other words, I believe that many Pep Boys locations have significantly more space than the company knows what to do with.

To that end, in lieu of the near-term bottom line performance, investors should instead focus their attention on the company's guidance as well as what management says regarding future comp growth and the direction of the company's higher margin service business, which has been dinged in the past by (among others) Wal-Mart. But the future seems not as slippery.

While investors now have every right to be encouraged by the company's direction, keep in mind that this has also become a story about valuation. With the stock already up close to 30% on the year and trading at its 52-week high, I would be taking some money off the table here.


With that said, it wouldn't surprise me to see the stock sell-off even after a better-than-expected earnings performance. Even when looking at Pep Boys' fiscal 2014 EPS estimates, which cuts the P/E by one-third to 17, the stock is still trading 3 points higher than both Auto Zone and Advance Auto Parts, which trades at fiscal 2014 EPS estimates of 13.

Bottom Line

Pep Boys today is far different than where the company was a year ago. After so many long battles with failed improvement attempts, Pep Boys no longer has to answer the question regarding its business model and whether it can still work. The recent performance and clear fundamental shift to service-oriented business suggests that the model is progressing well.


Clearly, I like Pep Boys today more than I did in April. But there are still better investment opportunities out there.

At the time of publication, the author held no position in any of the stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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