We're going Long Advance Auto Parts (AAP). We’ve been getting incrementally bullish on Auto Parts retail and AAP is the operational and financially levered way to play the space. As it relates to near-term setup, we think that that current quarter estimates are too low by 15%. Importantly, the company will host an Analyst Meeting shortly after beating 1Q where we think it will provide a roadmap as to how it gets to $15 in EPS power (12% EBIT margins) vs $8.51 (7.4% margin) in the year just reported. All this while stimulus is hitting checking accounts, and miles-driven inflects to the upside. Given the company's mixed past as it relates to delivering on promises to closing the margin gap vs competitors, we think that management knows it's on the hot seat and has to provide a very compelling case that it can actually achieve. If you believe what management is about to say, you've got a 20x p/e on $15 in EPS -- or a $300 stock vs $160 today. We'll wait to pass judgement until we hear to pitch, but if there was ever an operating environment for management to boost both productivity and margins, this is it. Our model has the company earning 2022 EPS a year early, and getting to 10% EBIT margin in FY22, suggesting 60% upside in 2-years.
The Auto Parts Aftermarket Industry
There are several reasons we are getting more bullish on the Auto Parts industry after going bearish in Spring 2020 and watching these names be some of the worst performers in all retail starting around June 2020.
First is the miles driven trend. Miles driven fell off dramatically starting around mid March 2020. At the bottom passenger miles were down about 55-60%, they have gradually recovered to down about 10% with slightly strong trends around holiday. We expect miles will recover back to somewhere around 95% of pre-covid levels, and the YY growth is about to inflect to very positive. This will be an industry tailwind, particularly on DIFM (Do It For Me).
Next is the car parc which, after being about a 5-6 year headwind to demand, is no inflecting to a multi-year tailwind. The ramp in new vehicles sold in the 2011-2016 time frame are aging into the sweet spot of maintenance consumption. This is extremely bullish for the auto parts retail space.
Third is weather (which we hate referencing, but it matters), after an extremely mild winter in 2019-2020, this winter has been fraught with winter storm and periods of extreme cold in various regions. Storms, road salt, and cold all mean extra wear on vehicles on the road which should be a demand driver both on part failure and maintenance needs.
Fourth, is the consumption tailwind of the likely big round of stimulus coming this spring.
Lastly, is industry consolidation as smaller competitors were forced out of business in the pandemic disruptions driving some share and M&A opportunities for the big players. The concern for the industry is ‘tough compares’ and potential demand pull forward in DIY. However we think a good portion of the DIY success was in discretionary categories and maintenance that can be repeated in 2021.
AAP
Along with riding the industry tailwinds, AAP has some unique opportunities.
The first point for AAP is that the company doesn’t really have tough compares. Even with the perceived stimulus bump, AAP comp sales were up just 2.4%, and EBIT was just 4%. That’s not a difficult comp. The reason AAP didn’t perform as well is that is has the highest DIFM penetration, which was hurt last year and is a big tailwind for 2021 as that is the business that has easiest compares and will be improving YY alongside miles driven for the entire year.
AAP also has some of the highest store penetrations in the northeast corridor where travel and covid restrictions were the highest for most of the year, as we see a full reopening in 2021, the region will see some of the strongest YY demand trends.
AAP has solid near term sales trends starting 1Q with low double digits comps, which are only going to get better as the company hits easy compares in March when weekly sales were down 28% by month end in 2020, so we see upside to current comp expectations for 1Q.
Early April compares are easy as well, so we suspect the company will be announcing a solid 1Q (we're at $2.85 vs the Street at $2.50) and strong quarter to date trends heading into its Investor Event on April 20th. That event will be an important catalyst, as we expect the company will set some long term margin targets in the low-double-digits vs the Street at 9% in perpetuity. Importantly, given that the company has failed to deliver on the big margin upside over the past three years, management knows that it will need to crisply map out how AAP will close the margin gap with its competitors. The margin upside for AAP has always been part of the bull case, but we think given some recent industry headwinds are inflecting to tailwinds, the likelihood of driving some margin upside is as high as ever.
We think 2021 EPS will come in around $11 vs the street currently at $9.75, and we see Tail earnings power about 20% ahead of consensus. AAP is trading at a trough relative multiple, and as we start to see revisions upwards, we think the multiple is like to go to 20x, suggesting a stock of $220, or 40% upside from current levels. If we're right and AAP delivers 10% margin in 2022, then we're looking at ~$255 stock, or 60% higher. To be clear, we think the company will lay out targets that will get margins to at least 12%, which suggests $15 per share in earnings power, or a ~$300-$325 stock -- a double in the stock over 2-years if they actually do what we think they'll say.
Quads
In Macro Quad2, we’ve been adding many small cap, high short interest, high beta names to our long list. Auto Parts is quality, AAP is not a typical Quad2 ticker, but it is the highest ‘leverage’ play in auto parts. Also, we think this and ORLY are the kinds of names you want to be nibbling at as we get closer to transitioning out of Quad2 and into Quad4. Auto parts names in aggregate have historically done very well in Quad 4 on both a relative and absolute basis.
