ORLY - Advance Auto Parts Q1 Earnings: Too Many Headwinds Avoid

2023-05-31 10:30:00 ET

Summary

• We have previously traded Advance Auto Parts, Inc., while we currently own both AutoZone, Inc. and O'Reilly Automotive, Inc.
• Advance Auto Parts is clearly being outcompeted.
• Margin compression has severely weighed on earnings power.
• Advance Auto Parts, Inc. sales are holding up relatively fine, but the company is burning cash now and it has slashed its dividend.
• AAP's EPS outlook has been cut dramatically for the year, a trader could catch a bounce, but there are so many better places to make money.

As you may know, we have traded Advance Auto Parts, Inc. ( AAP ) several times over the last few years, but this stock has always been our least favorite in the space. We have much preferred to get our members into AutoZone, Inc. ( AZO ) and O'Reilly Automotive, Inc. ( ORLY ).

We have had a neutral rating on AAP stock, but appears we missed a short opportunity. Shares are getting crushed today. The company just reported disappointing Q1 results , slashed its outlook, and even cut its dividend. It was a bit of a kitchen sink quarter. The company in our opinion is being outcompeted, but is also facing ongoing inflation, a weakening consumer, and questionable demand trends.

The thing is that auto part suppliers tend to hang in there in a tough economy as people attempt to keep cars on the road longer. And we need to be realistic, high rates are definitely starting to weigh on the consumer as with higher interest rates, financing a new auto loan is expensive. Bank lending is starting to tighten up.

This should be a benefit, but it seems Advance Auto Parts is losing some market share to the competitions. As of now, the economy is still on relatively solid footing, but that could also change quickly, so it's another possible headwind.

The company's results for Q1 were mixed and the outlook was slashed. The stock is getting crushed. It is a tough call here, but we think you still need to avoid this stock with the dividend also being cut. Let's examine the critical metrics of the company.

Being outcompeted

At BAD BEAT Investing, we have traded both AZO and ORLY for gains recently. AAP had been on our watchlist but had been neutral rated, with a potential for trading. But as we examined the very successful performance of both ORLY and AZO, it stands to reason that AAP is losing market share. The sales results were not horrific, but the outlook is quite poor. We have held AutoZone for large gains, and also have a house position in O'Reilly Automotive following another winning trade we made . Both stocks have been very strong. While we have also traded AAP and Advance has still grown successfully over the years, the stock is in rough shape here. It may be a buying opportunity for the long-term investor, but the near-term outlook and best move is to remain cautious.

Advance Auto Parts' Q1 Sales

The company just put out its Q1 report, and it was another quarter of gains and growth for the company, but far less than usual. Net sales in Q1 were $3.42 billion, a 1.5% increase from last year. The most critical indicator that we watch for retailers like this are comparable store sales.

Sales had also been rising nicely the last few years, but volumes have been softening, despite pricing power. Comparable sales were down 0.4%. We hate to see comp sales fall.

We dare to say that AAP stock deserves to fall on that data point alone. These weak comps led to revenues coming in a touch below consensus expectations overall. Margins were mixed and it weighed on earnings power.

AAP Q1 earnings results

Advance Auto Parts revenues increased marginally, but the margins on the revenues, which are usually strong, saw mixed results from last year. Adjusted gross profit margin in Q1 was down 2.4%. Ouch. It came in at 43.0% of net sales, a 162 basis point decline, which was driven by inflationary product costs that were not fully covered by increasing pricing. In addition, unfavorable product mix and supply chain headwinds also contributed to gross margin weakness. Here is the rub. However, other expenses weighed, and increased as a percentage of sales, and operating margin fell. So gross margins were down, and selling expenses were up. SG&A was 40.4% of net sales, which was a 180 point increase from last year. There were once again much higher wages as well as higher delivery costs that weighed, as well as new store openings.

Taken together, we see that adjusted operating income was just $90.0 million, a decrease of 56% vs. the prior year. This was a horrible result. So operating income fell, but what about the actual final earnings? Earnings fell from last year, while competitors are expanding EPS dramatically. The company's EPS was $0.72, compared with $2.26 in the first quarter of 2022. That is a terrible result. The company also burned cash.

Net cash used in operating activities was $378.9 million through Q1 versus $54.9 million used in operating activities last year. Free cash flow through Q1 was an outflow of $468.9 million.

As a result of these actions, the company slashed its dividend by 83%, which was a primary reason for owning this stock. Repurchases were $12 million of stock down from $264 million in repurchases a year ago. It is amazing to see the EPS hit despite ongoing buybacks, too.

Forward look

The AAP board of directors made the decision to reduce its quarterly cash dividend to provide enhanced financial flexibility. The dividend is now just $0.25 quarterly.

Now, talk about slashed guidance . It was horrific. The company previously saw sales of $11.4-$11.6 billion. This has been reduced to $11.2-$11.3 billion. That revision is lower, but not drastically, yet comparable sales will be negative to flat at best, but the biggest issue here is that there is massive margin compression and the EPS outlook was cut by 40%. Folks, this is terrible. The company cut guidance from $10.20-$11.20 for the year down to $6.00-$6.50. Advance Auto Parts, Inc. stock deserves to trade much lower on this news.

Final thoughts

This quarter and the outlook should give Advance Auto Parts, Inc. bulls pause. We missed a short opportunity but never saw a quarter this terrible in the cards, especially when we saw the strength of AZO and ORLY which we have our members in. We thought AAP was growing closer to a buy, but never got there. With this horrible outlook, Advance Auto Parts, Inc. stock is to be avoided. We are no longer looking to buy here. A tactical trader could attempt to catch small bounce in this selloff, but there are much better places to make money right now than Advance Auto Parts, Inc.

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