Advance Auto Parts Still Attractive After Stock Advance

Our $154 fair value estimate for narrow-moat

We have argued that Advance was unjustifiably punished for its disappointing recent performance and overblown fears of digital disruption. We believe the sharp post-earnings appreciation in Advance’s shares lends credence to our contention.

The third-quarter results and management’s indications that cost and infrastructure optimization efforts are progressing give us comfort that Advance is working toward our long-term targets, calling for 4% revenue growth and adjusted operating margin expansion to around 12% from 2018-26, versus a 2% revenue dip and 7% profitability mark (around 250 basis points lower than 2016) expected in 2017.

Management reiterated its 2017 guidance of a 1% to 3% comparable-store sales dip and around 200-300 basis points of adjusted operating margin deterioration, consistent with our targets. The industry remains hampered by what we see as a cyclical slowdown (as higher fuel prices temper miles driven growth and the smaller financial crisis-era cohort of vehicles enter retailers’ repair sweet spot), though we expect conditions to improve in 2018 as comparisons ease.

Despite early signs of stabilization, a full turnaround should take years, as Advance improves parts availability and rebuilds sales relationships. While Advance is becoming more efficient, cost leverage is critical to long-term profitability gains. Our call for about 130 basis points of adjusted operating margin expansion (to 8.2%) in 2018 is based on 2% revenue growth, but we contend that a return to mid-single-digit top-line performance is essential to returning profitability to the double digits, which we expect in 2020.

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