2023-11-01 04:55:50 ET
Summary
- CarParts.com is a leading online automotive provider of aftermarket auto parts and accessories.
- The company experienced a surge in demand during the COVID-19 pandemic but has since seen its share price decline.
- We are cautious about the company's weakening gross margin and competitive environment, and we await improvements in profitability before taking a more positive stance.
Investment Thesis
We are enthused by the overall aftermarket industry amidst vehicle ages of 6+ years becoming the new normal and the customer's quest for value could lead them to search online. In addition, CarParts.com's (PRTS) app can bring down the marketing dollars spent on search engine and performance marketing which can aid some EBITDA margin expansion. However, its weakening gross margin, lowest since 2019, as well as soft consumer environment amidst intense competition keeps us on the sidelines despite perceived attractive valuation. Initiate at Neutral and we await tangible improvements to deliver sustainable 5%+ EBITDA margins.
Company Background
CarParts.com is a leading online automotive provider of aftermarket auto and parts accessories. It has a comprehensive portfolio of over 900k+ SKUs across wide range of vehicle makes, models and years including exterior parts, engine components, chassis, mirror as well as other mechanical and electrical parts. The company's share price had a meteoric rise during COVID as a result of strong demand boom for auto parts online as a result of shutting down of offline stores amidst COVID-19. However, post pandemic reset with customers opting for best deals with offline channels led to the company's share price tumble to its pre-COVID levels.
Historical Financials
The company had reported a tepid growth prior to pandemic with revenues declining by over 2% CAGR during 2016-2019 period along with stable gross margins of ~30%. The tepid growth during the pre-COVID era also could be attributed to the fact that the company operates in a technically complex auto industry with consumers looking for professional advice to get their car repaired, a service which is inherently missing in an e-commerce operation. However, pandemic provided a much needed flip to its business as the demand for car products online skyrocketed amidst shuttering of the offline channels which led to a robust 33% revenue growth during 2019-2022 period. In addition, improving product mix and utilization has also enabled them to unlock margin opportunity which improved to 35% post-pandemic. On the flip side, the company's aggressive marketing spends to drive growth along with higher fulfilment costs lead to EBITDA margins remaining sub-4%.
Industry Trends
Consumers have been deferring the purchases of new cars as a result of tough macro backdrop and inflationary headwinds squeezing their wallets. This has led to average age of vehicles rise up for the sixth consecutive year and also the highest yearly increase since the Global financial crisis where in recessionary pressures lead to an increase in age of the vehicles. According to S&P Global Mobility and Transunion , demand for auto loans has slipped below the COVID levels (Q3 2020).
Demand of US light vehicle sales which was affected as a result of the semiconductor shortage during the pandemic is expected to rebound strongly for the current year and grow steadily before plateauing near the 16 mn mark, remaining below the pre-COVID levels.
We believe the aftermarket industry would be benefited by increasing vehicle age requiring regular and more frequent maintenance services as well as growing share of vehicles with more than 6 years of age ( 74% of vehicles are expected to be aged more than 6 years by 2028). However, labor and technician shortage could push up wage costs in order to retain talent and improve customer service amidst competition which could further put a dent in the gross margins.
Muted Q3 Earnings
The company reported muted Q3 earnings with sales up 1% YoY at $167 mn, despite a softening consumer environment, driven by strong unit growth which was largely offset by price deflation. Gross margins declined by 180 bps YoY to 32.9% primarily driven by higher transportation costs along with adverse product mix. Branded product share improved from 13% to 16% which has a lower gross profit margin compared to its own private label sales. Cost per package also increased about 2-3% which could not be passed on to the customers amidst intense competition and muted consumer environment. The sub-33% gross margin reported was the lowest level of margins the company reported since 2019 remains a cause of concern, particularly as a result of its razor thin margin profile.
Operating dollar expenses increased 2% as a result of a continued increase in advertising and marketing expenses to drive growth partially offset by a decline in fulfilment costs. SG&A expenses deleveraged by 20 bps YoY as a result of sticky operating expenses and higher marketing spends outpacing revenue growth. Adj. EBITDA halved to $3 mn with margins declining by 200 bps to sub-2% primarily due to decline in gross margins.
The company's balance sheet remains strong having ended with cash balance of $67 mn and no debt compared to $19 mn in cash balance at the end of last year driven by strong cash flow from operations and working capital improvements primarily as a result of improving realization of its account payables (working capital release due to account payables of ~$31.5 mn compared to $4.5 mn on a YoY basis). It also repurchased shares of 245k during the quarter with a cumulative value of over $1 mn.
The company guided for full year revenue growth to be in low single digits, down from its earlier low to mid single digits guidance. We believe Q4 revenue growth will likely be ~2% which would enable the company to meet its low single digit growth guidance. We believe gross margins are likely to inch above the 33% mark as it laps some of the freight charge increase last year. However, we believe the continued marketing spends which is expected to be higher on a YoY basis will keep the operating margins subdued.
Valuation
Seeking Alpha's Valuation grade ascribes an 'A' rating primarily as a result of undervaluation compared to its peers as well as historical averages. The company trades at 7.6x EV/ Fwd EBITDA and 0.3x EV/ Fwd Sales which is at a discount to sector median at 9.0x and 0.8x respectively. While it appears that the company trades at a significant discount to its historical average, we compare it during the pre-COVID era where in it used to trade at an average 7x TTM EBITDA and about 5x Fwd EBITDA. This implies that the company is still trading above its pre-COVID historical average which is warranted due to relatively higher growth and stable margin profile since the pandemic.
We believe the relative discount is warranted primarily as a result of weaker margin profile and poor return ratios compared to its peers.
We believe the company is likely cheap, however, given the weakening margin profile and its inability to improve its gross profits amidst weakening consumer environment would mean continued near term risks clouding visibility. Initiate at Neutral.
Risks to Rating
Risks to rating include
1) Company operates in a highly competitive and fragmented automotive aftermarket competing with giants such as AutoZone ( AZO ), O'Reilly Auto ( ORLY ) as well as Advance Auto Parts ( AAP ), Monro ( MNRO ) and other local and regional players as well as gas stations and mass merchandisers
2) Growth in EV car sales would lead to a decrease in maintenance service requirements which might affect its operations
3) Higher advertising spends may not lead to favorable customer additions which can in turn significantly affect its margin profile
4) Upside risks include outsized growth in maintenance and repair services due to increasing vehicle age, customers shift to e-commerce channel to find better value and continued shareholder activity including repurchases
Final Thoughts
Carparts.com is affected by weakening consumer environment and margin profile for higher marketing spends amidst consumers flocking to the nearby auto garage to service their cars. We believe the aftermarket auto industry is likely to be a beneficiary of the increasing vehicle age which are likely to require regular maintenance services. However, the company's relatively weak operating metrics remains a concern and we remain on the sidelines till we see any tangible improvements and visibility on the company's ability to drive sustainable 5%+ EBITDA margins.
For further details see:
CarParts: Undervalued For A Reason, Initiate At Neutral