One of the types of investments that I love is what I call “infrastructure plays.” I don’t necessarily mean massive things like pipes and concrete, but instead the companies that handle things that other companies need. In the case of cars, it’s auto parts stores like Advance Auto Parts, Inc. (NYSE:AAP).
All machines break down and need maintenance. All machines need parts replaced. There are 268 million cars on the road in the U.S., and when we multiple that by the number of parts in those cars, you can see why this is big business.
Also, auto parts stocks like Advance Auto Parts stock benefit no matter what the economy is like. If the economy tanks and people stop buying new cars, they shift to used cars. That’s great because used cars need parts more often than new cars.
AAP stock and its peers also benefit from lousy weather, especially cold and snow. The worse it is, the more pounding cars will take and the faster they need parts.
Independent parts stores like Advance Auto Parts also provide a way for both consumer and commercial customers to get parts without going to the dealer or manufacturer for an expensive OEM part.
However, it’s tricky to value Advance Auto Parts stock and its peers because auto parts is an extremely competitive industry. Same-store comps and revenues will fluctuate based on who gets the upper hand in market share. So there isn’t a straight-line growth chart you can expect from any of them.
Advance Auto Parts stock has also floundered because it had trouble digesting a $2-billion acquisition of another parts chain in 2014. But things seem to be turning around.
Comps fell 2.6%, which is not good at all. That triggered declines across the board. Q4 revenues were down 2.2%, gross margin fell to 42.9% down 69 bps, adjusted operating income fell 45 bps, and operating income fell to $87 million down 82 bps. However, operating cash flow rose 15% to $601 million for the full year, and free cash flow was $411 million, up from $264 million.
Net income came in at $185 million for the quarter and $475 million for the year.
Basically, AAP managed to optimize its working capital and cut expenses.
2018 guidance suggests net income should come in a bit higher amid higher operating margins and improved same-store comps. With $547 million in cash and $1.04 billion in debt, Advance Auto Parts is in fairly solid condition.
Bottom Line on Advance Auto Parts Stock
So with an $8.4-billion market cap, Advance Auto Parts stock trades at about 17.5x earnings, a bit under O’Reilly Automotive Inc (NASDAQ:ORLY) which trades at 19x. However, AAP stock trades at 40% below its all-time high, while ORLY stock trades at 20% off.
I think AAP has a ways to go, but as opposed to many other companies in turnarounds that I don’t care for because they are in tons of trouble, AAP has a real shot. There’s a lot to like here, and while Advance Auto Parts stock feels a bit pricey, I think very patient long-term investors will see upside if they buy in here.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance, and is the Manager of The Liberty Portfolio at www.thelibertyportfolio.com. He does not own any stock mentioned. He has 23 years’ experience in the stock market and has written more than 2,000 articles on investing. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.