Advance Auto Parts Looks Cheap
Although management’s 2018 guidance lags our targets, we remain favorably disposed toward narrow-moat Advance’s (AAP) long-term turnaround, and as our view of the endgame (mid-single-digit top-line growth, adjusted operating margins approaching 12% over the next 10 years) remains the same, our $155 per share valuation should hold fairly steady.
The company’s 2017 results ($9.4 billion in revenue, 7% adjusted operating margin) met our expectations, though its call for $9.1 billion to $9.4 billion in revenue and a 7.3%-7.8% adjusted operating margin in 2018 trails our $9.6 billion and 8% respective outlook. However, we have argued that Advance’s turnaround is a long-term story, with results materializing over the next few years, not quarters. Our long-term forecast is more conservative than management’s earlier calls for 500 basis points of operating margin improvement from 2017 to 2021; we incorporate less than 200 basis points, expecting just over 11% by the end of the same period. Our conservatism reflects the uncertainty associated with the company’s resuscitation efforts.
Advance’s turnaround benefits from an industry environment that should support the firm over the long term. A combination of normalizing winter weather conditions, the gradual easing of pressure associated with the smaller 2008 to 2011 cohort of new vehicles’ move into retailers’ repair sweet spot (cars and trucks aged roughly seven years and older account for the core of industry sales), and ongoing consolidation behind scaled, high-service retailers should create a meaningful tailwind. For these reasons (particularly weather), Advance’s guidance could prove conservative, and even if not, we contend the slower improvement cadence is more reflective of the pacing of the firm’s complex turnaround than the ultimate endpoint, leading to our neutral valuation take (more meaningful-than-expected tax reform would also act as an offset to a softer short-term outlook).
Morningstar Premium Members gain exclusive access to our full analyst reports, including fair value estimates, bull and bear breakdowns, and risk analyses. Not a Premium Member? Get this and other reports immediately when you try Morningstar Premium free for 14 days.
