Penn Wealth Publishing

2017.10.04 Penn Wealth Report Vol 5 Issue 02

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04 OCT 2017 PENN WEALTH REPORT VOLUME 5 ISSUE 02 13 PENN WEALTH REPORT Copyright 2017. All Rights Reserved. INVESTMENT INTELLIGENCE Auto Parts Auto Parts Crash and Burn The bloodbath began on the 23rd of May, when retail auto parts chain AutoZone (AZO $491-$510-$818) surprised investors with a weak fiscal Q3. The stock was the single worst performer in the S&P 500 that day, falling 12%. Then came Advance Auto Parts (AAP $99- $105-$178), followed by O'Reilly (ORLY $169-$186-$293)—which fell a full 20% in early trading on the 5th of July. At that point the lemmings, collectively known as the financial media, had no choice but to appear to have a grasp on the train wreck before them, assuring viewers/readers that they saw it com- ing all along. It was the "Amazoning" of the auto parts industry!" "Inevitable," they now proclaimed. You could, apparently, expect this trend to continue, as they lumped the grease monkeys in with the dying (their words, not ours) mall fashion industry. There was one voice of reason in the crowd. On CNBC, auto and airline reporter Phil LeBeau urged caution. "People aren't going to start ordering auto parts on Amazon; they are going to get in their cars and drive to the nearest auto parts store." Secondly, he argued, the "sweet spot" for DIY mechanics hitting the auto stores came when their cars hit the seven- to ten-year-old range. What happened seven to ten years ago? The financial crisis. What hit the skids during the financial crisis? You guessed it—auto sales. Therefore, wouldn't it make sense that the slowdown in the rate of growth of this industry had something to do with that period? LeBeau's arguments made a lot of sense. He looks like the kind of guy who has actually put brake pads on a vehicle before, unlike Little Lord Fauntleroy (David Faber) and the other geniuses who had already written the epitaph for the industry. If we are correct, and this is a massively good buying opportunity, which auto parts store looks the most ripe for the picking? Size and Valuations. One factor that is now always danc- ing around in our minds when researching an industry is the like- lihood of a merger or acquisition. All other metrics being equal, why wouldn't you go for the $5 billion mid-cap with a reasonable debt load versus the $105 billion market cap behemoth? OK, none of these play- ers are near the latter's size, but one did catch our attention. Advance Auto Parts, as it lay their in the after- math of a year-long carnage, was sitting at a lucky $7.777 billion market cap (as of the time of our research). That is compared to Genuine Parts (GPC $81-$83-$105) at $12 billion, AutoZone at $14 billion, and O'Reilly at a lofty (for this industry) $17 billion. If ORLY wanted to knock out the competi- tion, or if the others wanted to catch up to the big dog, what better pick-up than Advance? If a merger did coalesce, AAP's fair value of $170 per share would equate to a 62% spike in price—and that is not even accounting for the inevitable premium offered! Let's talk about valuation. Hopefully, everyone now understands that a company's share price is completely irrelevant when it comes to determining whether a stock is "cheap" or "expensive," so for- get about it (though it is handy to note where a company is sitting relative to its 52-week low and high prices). Looking at the price- to-earnings ratio, we see that all the major players are in the 15-20 range, which is historically about right for the industry. Reviewing the price to price-to-sales (P/S) ratio for the trailing twelve months, however, reveals that AAP is sitting at about half the level of its competitors. In other words, it is undervalued in the pack, based on actual revenue. There's another fundamental reason we like Advance Auto Parts over its peers. A little over three years ago, AAP shelled out $2 bil- lion in cash to buy General Parts, which happened to be the parent of Carquest Auto Parts. That acquisition was huge in that it gave Advance a giant footprint in the commercial auto parts distribution network. This strategic move also handed Worldpac, which pro- vides parts for imports, over to AAP. The company now boasts 5,200 locations across North America, and another 1,250 Carquest shops. Forget massive distribution centers; the name of the game in this industry is "convenient and nearby." We didn't pick up AAP looking for a quick buck; rather, we added it to the stalwart Global Leaders Club in search of long-term growth. We bought the company at $105.24 on the 5th of July. Amazon is getting in people's heads, and it has led to a great opportunity in auto parts

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