Advance Auto Parts’s stock price has taken a beating over the past six months, shedding 22.5% of its value and falling to $30.94 per share. This may have investors wondering how to approach the situation.
Is there a buying opportunity in Advance Auto Parts, or does it present a risk to your portfolio? Check out our in-depth research report to see what our analysts have to say, it’s free.
Why Do We Think Advance Auto Parts Will Underperform?
Even though the stock has become cheaper, we're cautious about Advance Auto Parts. Here are three reasons why there are better opportunities than AAP and a stock we'd rather own.
1. Flat Same-Store Sales Indicate Weak Demand
Same-store sales is an industry measure of whether revenue is growing at existing stores, and it is driven by customer visits (often called traffic) and the average spending per customer (ticket).
Advance Auto Parts’s demand within its existing locations has barely increased over the last two years as its same-store sales were flat.
2. Shrinking Operating Margin
Operating margin is a key profitability metric because it accounts for all expenses necessary to run a store, including wages, inventory, rent, advertising, and other administrative costs.
Analyzing the trend in its profitability, Advance Auto Parts’s operating margin decreased by 8.3 percentage points over the last year. Advance Auto Parts’s performance was poor no matter how you look at it - it shows that costs were rising and it couldn’t pass them onto its customers. Its operating margin for the trailing 12 months was negative 7.8%.
3. Short Cash Runway Exposes Shareholders to Potential Dilution
As long-term investors, the risk we care about most is the permanent loss of capital, which can happen when a company goes bankrupt or raises money from a disadvantaged position. This is separate from short-term stock price volatility, something we are much less bothered by.
Advance Auto Parts burned through $96.17 million of cash over the last year, and its $4.15 billion of debt exceeds the $1.87 billion of cash on its balance sheet. This is a deal breaker for us because indebted loss-making companies spell trouble.
Unless the Advance Auto Parts’s fundamentals change quickly, it might find itself in a position where it must raise capital from investors to continue operating. Whether that would be favorable is unclear because dilution is a headwind for shareholder returns.
We remain cautious of Advance Auto Parts until it generates consistent free cash flow or any of its announced financing plans materialize on its balance sheet.
Final Judgment
Advance Auto Parts doesn’t pass our quality test. Following the recent decline, the stock trades at 19.6× forward P/E (or $30.94 per share). This multiple tells us a lot of good news is priced in - we think there are better opportunities elsewhere. We’d recommend looking at one of our all-time favorite software stocks.
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