Advance Auto Parts: Valuation To Trade At A Discount To Peers

Investment Summary - Advance Auto Parts, Inc. (AAP) is rated as a hold due to the sale of Worldpac being positive for shareholders, but the stock is expected to trade at a discount relative to peers because of the gap in EBIT margin over the medium term [2]. Business Overview - AAP operates as an aftermarket parts provider for the automotive industry, with 4,776 stores as of 2Q24. The revenue breakdown is approximately 40% from DIY and 60% from Commercial segments [3]. 2Q24 Results Update - In 2Q24, net sales slightly decreased by 0.1% year-over-year to $2.68 billion, with comparable store sales growing by 0.4%. Gross margin fell by 93 basis points to 41.5%, primarily due to strategic pricing actions and higher product costs. Operating costs increased by 2.8% year-over-year to $1.04 billion, leading to an EBIT margin of 2.7%, which was 80 basis points below consensus estimates [4]. Worldpac Sale - AAP is set to sell its Worldpac business unit to Carlyle Group for $1.5 billion in cash, with net proceeds expected to be $1.2 billion after taxes and fees. The transaction is anticipated to close by FY24, which is seen as positive for shareholders as it allows for deleveraging and investment in turnaround initiatives [5][6]. Margin and EBITDA Analysis - Over the last twelve months, AAP generated approximately $359 million in GAAP EBITDA, with $100 million from Worldpac. Excluding Worldpac, AAP's EBITDA was around $259 million, indicating an EBITDA margin of approximately 2.8% and an EBIT margin of around 0.5%. Management aims to expand the EBIT margin to mid-single digits over the next two years, which is considered poor guidance compared to peers like AutoZone and O'Reilly, which have EBIT margins around 20% [7][8]. Strategic Pricing Investments - AAP is increasing its strategic pricing investments, adding an additional $60 million in 2Q24 to a previously announced $40 million, totaling $100 million annually. While this strategy may align with current consumer spending trends, there are doubts about its effectiveness in significantly changing the margin outlook [8]. Demand Trends - Demand trends are not favorable, with consolidated comparable sales growing by only 0.4% in the quarter, primarily driven by strong DIFM performance. The DIY segment continues to face pressure, and management has noted a softening in trends for both segments due to macroeconomic headwinds and a challenging comparison from the previous year [9]. Valuation - AAP currently trades at a forward P/E of 15x, compared to 26x for O'Reilly and 19x for AutoZone. This discount is justified due to the significant gap in EBIT margin and AAP's higher leverage ratio of 3.5x compared to peers [10]. Conclusion - The outlook for AAP remains a hold rating, as the company is likely to continue trading at a discount to peers due to lower EBIT margins, pressured near-term sales performance, and a higher leverage ratio [11].