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Stock Analyst Update

Advance Auto Parts Still Attractive After Stock Advance

Shares of the narrow-moat company soared after the company posted good results, but we think they're still undervalued.

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Our $154 fair value estimate for narrow-moat  Advance Auto Parts (AAP) should not change much after the company posted third-quarter earnings that leave it on track to meet our 2017 targets. Although our reaction is far more tempered than the roughly 20% uptick the shares saw shortly after the announcement, we remain convinced that the stock is attractive.

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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Zain Akbari does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.