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Is Advance Auto Parts Stock a Buy?

Motley Fool - Fri Sep 15, 2023

While technology companies, particularly those with exposure to artificial intelligence, have received all the attention lately, some investors might be looking at more under-the-radar names to find some worthy ideas. Maybe Advance Auto Parts(NYSE: AAP) has caught your eye recently.

This aftermarket auto parts retailer currently trades at a price-to-earnings ratio of just 10. That depressed valuation shouldn't be surprising, given that the stock has tanked 65% in the past five years.

Value-focused investors who are considering buying shares right now should think twice, however. Here's why it's probably best to stay away from Advance Auto Parts.

A troubled history

To see a stock that has dropped so much in the past five years, especially in comparison to the 55% gain of the S&P 500, is alarming for sure. This type of terrible performance typically only happens if the business is posting weak financial results, which is exactly what Advance Auto Parts has been doing.

During the five-year period between 2017 and 2022, the company's revenue only increased at a 3.5% annualized pace, with net income rising at a paltry 1.1% clip. These poor results occurred mainly during the involvement of Starboard Value, a prominent activist investment firm that tried to fix the issues. Starboard took a stake in Advance Auto Parts in late 2015 with the goal of expanding margins to get them in line with peers. This project failed to result in the intended changes, and the investor completely exited its position in 2021.

And just in the most recent quarter, Advance Auto Parts' same-store sales declined 0.6%. Management also downgraded the guidance for the full-year operating margin, now expecting it to come in between 4% and 4.3%. The company cut its dividend, and the leadership team announced a strategic review to assess the direction of the business. It's no wonder the stock is down 61% this year alone.

An inferior industry player

Advance Auto Parts' struggles are even more disappointing when analyzing its more successful peers in the industry, Autozone and O'Reilly Automotive. In the last five years, the former's stock price has soared 231%, while the latter's has jumped 166%. They are clearly doing something right.

Autozone and O'Reilly have seen their revenue increase at compound annual rates of 8.3% and 9.9%, respectively, in their last five fiscal years. And both have been able to grow diluted earnings per share at an even faster rate, greater than 21% per year. This strong fundamental performance is key to why their share prices have gone up so much. Moreover, both of these industry heavyweights possess financial and operational prowess, as their stellar profit margins and ability to generate free cash flow indicate.

This industry doesn't require game-changing or disruptive capabilities to succeed, so there isn't a need for a true visionary of a leader who has grand ambitions about introducing new products or services to the market. That's certainly characteristic of the internet sector.

On the contrary, this is auto parts retailing, a boring and stable industry that relies more on operational excellence than being innovative. This basic reality should make one scratch their head at Advance Auto Parts' shortcomings. Perhaps the company's problem has simply been that its management team has failed over and over again. A new CEO, Shane O'Kelly, has now taken over the leadership position. The rational thing to do would be to just copy what the two thriving rivals are doing. And then maybe the business will start to head in the right direction. But there's too much uncertainty with this outcome, and it's reasonable to assume that the bad times will keep on rolling.

There's a lot to dislike about Advance Auto Parts. And as a result, I think investors would be better off if they just avoided the stock altogether. But if there's still an interest in investing in this industry, Autozone and O'Reilly, which have clearly shown that they can reward shareholders, should definitely be on your radar.

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Neil Patel and his clients have no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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