We Still See Value in Auto Part Retailers

 O'Reilly’s (ORLY) first-half results fell well short of our expectations, and, as a result of an industry slowdown that is more persistent than we initially thought, we plan a mid- to high-single-digit percentage cut for our valuations for narrow-moat O’Reilly (currently $264 per share), AutoZone ($790 per share), and Advance Auto Parts ($180 per share) and a low- to mid-single-digit dip for narrow-moat Genuine Parts ($96 per share). However, we contend that the industry’s recent stumble is cyclical rather than secular and not reflective of a longer-term shift toward digital retailers or other competitors. Our reaction is more muted than prevailing sentiment.

O’Reilly pre-announced 1.7% second quarter comparable sales growth, well short of management’s 3%-5% guidance. For the first half, the firm’s 1.3% mark lags its 5.1% performance in the same period a year ago and our 4.5% full-year target. Management cited weak demand and weather-related headwinds while reiterating confidence in the industry’s long-term health. We tend to agree, with motorists’ price-insensitivity supporting pricing and an aging vehicle fleet boosting demand. While we are concerned by the year-to-date slowdown in vehicle miles driven growth (a key measure of industry health; year-on-year expansion slowed in every month from January to April), we expect the recent dip in fuel prices should help improve the trend.

We anticipate large sellers should be far better suited to weather an industry slump than their smaller peers. With more opportunities to sell slow-turning parts by virtue of their dense store networks, scaled retailers have a significant working capital advantage that frees resources for service level improvements and other brand-building activities. Though a cyclical slowdown would temporarily strain revenue and margins (due to cost deleverage) across the board, market share gains among the firms we cover should accelerate as already-intense pressure on subscale retailers builds.

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