As I've discussed recently, if management is not careful, this company many not have enough gas to hang a U-turn and reverse course.
While Pep Boys has made some decent operational progress, investors are getting frustrated and wondering if the business model can still work. After so many long battles with failed improvement attempts, Pep Boys just needs to admit what the numbers already say: the model can't work.
There's no longer a point to hanging on to a failing business plan, which is causing investors plenty of headaches, while prolonging the company's recovery.
What Does Pep Boys Want To Be?
That's a question management has yet to answer clearly. Although expectations have been low for some time, the company continues to miss its targets. However, it seems that the focus is beginning to shift more to a services business and less on retail. I'm just not convinced that it's for the better.
The company's third-quarter results showed evidence for this, including a 2% revenue decline that also highlighted much fundamental and operational concerns. For instance, it is clear that merchandise, which fell last quarter by 3%, is a major problem.
Pep Boys, with rivals such as Advance Auto Parts
However, competition from traditional auto parts rivals is only part of the problem. There is also the likes of Wal-Mart
Although the company managed to increase Q3 service revenue by 1%, which also grew 0.2% on a comp basis, margin on the service business, which includes low-service oil changes, is not enough to have the sort of impact to make services a worthwhile focus -- and it showed.
Gross margin continue to erode, including a Q3 drop of 150 basis points. Even though the company deserves credit for service revenue growth, service margin still managed to drop by five points. This is despite the fact that customers have responded well with higher transactions.
An argument can be made that the higher traffic actually hurt. Here too, Wal-Mart, which has an auto services business of its own, is undercutting Pep Boys' margins. And from a profitability standpoint, it doesn't appear as if management has an suitable answer. So does Pep Boys want to be a service-oriented business or a retail business? The "joint model" is still not working - not to the extent that it does for AutoZone and Advance Auto Parts.
Expectations for the Fourth Quarter
According to Yahoo!
Average estimates for full-year revenue is at $2.07 billion, which would represent 0.2% year-over-year growth, or roughly flat from the $2.06 billion posted a year ago. The company is expected to report earnings of 31 cents a share, which would be a year-over-year decline of 42% from earnings per share of 54 cents. These are not exactly breath-taking numbers.
Absent some clear fundamental changes, it's hard to see a silver lining with Pep Boys, especially since this turnaround story has been going on now for 15 years. Management must still address the fact that its stores are often considered to be in "undesirable locations" and are inefficiently operated from the standpoint that the store seems to have more space than is utilized.
All of that said, the effort it would take for Pep Boys to fix itself is not impossible. However, it may require "getting worse" before the things get better.
Management should consider exiting the services business and focus solely on the retail end. Unfortunately, this would create additional "unusable space," which is already a concern. Thus, the "getting worse" part.
Suffice it to say, there are much better investment opportunities out there. And even for more risk-tolerant investors, this is not a stock bet on, especially since the valuation is already trading at almost twice that of Auto Zone and Advance Auto Parts.
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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