AAP with a strong quarter coming in 10% ahead of the street even with preliminary results announced back before the April Investor Day. Full year guidance at the higher end of the range suggests the street is about $1.00 in EPS too low heading into this print, and we’re coming in well above that. We think the margin expansion story is on track, albeit with the help of industry tailwinds. Analyst Q/A suggested some concern around the mix shift back to DIFM after strong DIY trends since last April as well as the general need for continued demand strength to drive the performance. We expect demand to remain strong in 2021. AAP management noted that QTD comp trends are at mid-teens, which suggests the strong 1Q two year trend has continued into 2Q. We expect some moderation in that trend in 2H but think comps remain positive. Weekly FHA interstate vehicle miles traveled continue to improve, though recently reported weeks are trending around MSD below 2019, so there is still a lot of runway for improvement. Add the fact that traffic congestion is starting to return (which amplifies vehicle wear, after a harsh winter) we think demand still has runway in 2021. The car parc trends and used vehicle demand/prices also suggests multi-year demand tailwinds for auto parts. DIFM demand is likely to continue ramping and management noted a “huge surge” -- the concern would of course be DIY demand falling off. Management noted the industry added 4mm new DIY customers over the last year, that should mean some sustained elevated levels of demand in DIY. DIY performed well despite limited spending tailwind in late 2020, with miles driven up and building vehicle wear, we think it’s likely to remain ahead of 2019 levels for several more quarters at least.
On the margin cadence, management’s guidance implies a slight tempering of 2021 margins in the context of a higher sales guide. There are two issues to be considered, one is the mix shift to DIFM from DIY (higher margin) that will be seen the remainder of the year. The mix shift however should have been contemplated in the prior guidance. The other revision here is inflation, which seems to be the more important change on the margin. Management stated that the February guidance implied inflation of 1-2% for 2021, that is now being viewed as 2-4%. So for 2021 we’re getting more bullish on sales, taking down margins slightly, while stepping up the buyback cadence given strong near term cash generation and the recent pullback in the stock.
Recall in the long term margin guidance on the Investor Day that inflation would be 280-290bps of cost pressure offsetting several initiatives driving potential expansion of 770bps (net 440bps on the top end). So perhaps we can imply inflation being a further headwind on Tail EBIT margin potential. However, at the same time the industry has had great success in passing through elements of inflation into pricing, so there is clearly a sales tailwind from inflation via higher comps, much like we saw with the tariffs a couple years ago. We still see management hitting its 2023 margin targets with at least 250bps of margin expansion from 2020 levels. The street is below the bottom end of the LT margin range and near the bottom end in sales, declaring this a show me story.
For 2021 we’re at EPS of $12.10, and we think the right multiple for AAP is in the high teens. We think that means a stock fair value around $220 today. Over the Tail we think EPS is heading to $16+ and the stock to $300+.
