Will Advance Auto Parts Shares Advance?

High-profile activist investor Starboard Value recently made a large purchase of automotive supply retailer Advance Auto Parts (NASDAQ: AAP). Starboard bought a 400,000 block of Advance Auto Parts stock last week, which amounted to a $62 million purchase.
Starboard was already a significant holder of Advance Auto Parts shares; the company initially took a 3.7% stake last September, and made a presentation regarding the company’s perceived future growth prospects.
Starboard is one of the company’s top 10 institutional holders, and it believes the company can significantly expand profit margins. The market doesn’t seem convinced, however; Advance Auto Parts stock is down 4% in the past one year, below the S&P 500 index performance in the same time.

Starboard’s Bullishness May Be Misplaced

In a letter to the company’s CEO, Starboard Value urged it last year to unlock value for shareholders by significantly increasing its dividend or shareholder buyback.
Unfortunately, the company has not taken Starboard’s advice. In 2015, Advance Auto Parts spent just $6.6 million on repurchasing its shares. After incorporating the dilutive effect of stock option grants to employees, the company’s average share count actually rose last year.
And, Advance Auto Parts doesn’t pay much of a dividend either. Its current annualized dividend of $0.24 per share amounts to a dividend yield of just 0.16% per year. By comparison, the S&P 500 index yields 2.1% on average.

Store Closures, Falling Sales

Advance Auto Parts maintains a rather stingy capital allocation program because the company is in a difficult position. Its fundamentals have stagnated over the past year. It is struggling with falling sales and has had to close stores.
Last year, Advance Auto Parts posted flat comparable sales, which is a crucial metric for retailers because it analyzes sales at locations open at least one year. This was a significant slowdown from 2% comparable sales growth in 2014. Also, Advance Auto Parts reduced its store count by 1.5% last year, which is likely to put further pressure on the company’s sales.
It will be difficult for it to return cash to shareholders when its underlying business is in trouble. This is particularly disappointing because the automotive parts industry is broadly enjoying a boom.

Advance Auto Parts Misses Out

Consumers in the U.S. are holding onto their cars for much longer than previous generations did. According to a July 2015 survey by IHS Automotive, the average age of cars still on the road in the U.S. is a record-high 11.5 years.
This is a tailwind for the auto parts retailers, who should benefit from consumers’ desire to perform “do-it-yourself” automotive repairs.
When Starboard first invested in the company last year, it acknowledged the difficulties facing the company. In Starboard’s presentation, it stated Advance Auto Parts had “materially underperformed” competitors like AutoZone (NYSE: AZO) and O’Reilly Auto Parts (NASDAQ: ORLY).
At the time, Starboard urged the company to make improvements to its working capital management and implement stronger cost controls to boost profit margins.
However, the turnaround plan has not worked as anticipated. In the first quarter, it was more of the same: Advance Auto Parts’ comparable store sales declined 1.9% year over year, and it reduced its store count by another 1.5%.
With the company continuing to struggle, it is confusing to see Starboard double down on its investment in Advance Auto Parts shares. Clearly, management does not see eye-to-eye with the activist investor.

Alternative: Go for an Industry Leader

Rather than piggyback on Starboard’s investment, investors would be better off buying either AutoZone or O’Reilly Auto Parts to capitalize on the growth of the auto parts industry.
AutoZone grew comparable sales and earnings per share by 2% and 12%, respectively, last quarter. Over the first nine months of its current fiscal year, the company’s EPS is up 13% versus the same period last year.
AutoZone’s sales are growing and its share buyback plan is boosting earnings; the company has reduced its share count by 5.9% over the past year.
Meanwhile, O’Reilly Automotive grew first-quarter comparable sales by 6.1%. The company generated record first-quarter operating margin of 20%, which drove a 26% increase in EPS. And, the company recently raised its share repurchase authorization by another $750 million.
It seems the things Starboard is looking for can be found in this industry, but not from Advance Auto Parts.

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