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Is Advance Auto Parts Stock a Buy?

Motley Fool - Thu Nov 30, 2023

I'd be putting it lightly if I said that shareholders in Advance Auto Parts(NYSE: AAP) have had a difficult time. It's been worse than that. Just this year, the stock has tanked 64%, while the broader S&P 500 is up nearly 19% (as of the morning of Nov. 27).

However, some might be eyeing the beaten-down valuation as a worthwhile opportunity. So, is this aftermarket auto retail stock a smart buy for investors right now? In my opinion, it's best to avoid the business altogether. Let's take a closer look at Advance Auto Parts.

Latest financial results

Shares of Advance Auto Parts have gotten so hammered as a direct result of disappointing financial results. The most recent quarter, which ended on Oct. 7, continued the worries. The stock is down more than 6% since that latest earnings announcement on Nov. 15.

Advance Auto Parts reported that revenue and same-store sales increased by 2.9% and 1.2%, respectively. Gross profit dropped 16.3% due to inventory reporting changes and higher product costs. And maybe most surprising, the business posted a net loss in the quarter.

That Advance Auto Parts lost money in the quarter is perhaps the most disappointing development for investors. In February, management forecast diluted earnings per share of $10.70 (at the midpoint) for fiscal 2023. Now, they expect that figure to come in between $1.40 and $1.80.

Unsurprisingly, to right the ship, the leadership team is engaging in cost-cutting measures while also working to sell Worldpac, its wholesale distributor, and Carquest, its Canadian operations. It's safe to say that a lot of things need to improve for investors to have any confidence in the direction of the business.

Operational challenges

Advance Auto Parts has been the target of an activist investor in previous years, who exited the position entirely in 2021 due to an unsuccessful campaign trying to turn things around for the struggling retailer. More recently, the company has brought in a new CEO, Shane O'Kelly. Additionally, Ryan Grimsland has just been named CFO. Both of these executives have extensive experience in the home improvement retail space.

Despite new faces, it's not easy to be optimistic about the direction of Advance Auto Parts. The business seriously lags behind more successful industry rivals. AutoZone and O'Reilly Automotive have been fantastic investments due to their operational prowess. They both consistently generate much greater margins, with significantly higher returns on invested capital than Advance Auto Parts.

The cash conversion cycle, a key metric for any retailer that measures the number of days it takes to convert cash spent on inventory to cash received from the sale of goods, is very telling. Advance Auto Parts' cash conversion takes 72 days, while AutoZone's and O'Reilly's are negative. This just means that they sell merchandise before even having to pay vendors for it. These numbers indicate that Advance Auto Parts needs to do a much better job at inventory management, providing customers with the right parts, in order to free up cash.

A value trap

It's tempting to want to buy shares of Advance Auto Parts while its price-to-earnings ratio sits below 17, especially since AutoZone and O'Reilly trade at much higher multiples. But this is a classic value trap. Investors hoping for a solid return are likely to be disappointed.

Shares are cheap for a reason, as the market fully understands that the business has a lot of work to do to get back on track. "Turnarounds seldom turn," according to the great Warren Buffett. This is exactly the correct mindset to adopt when looking at this troubled retailer.

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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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