2023-11-22 15:00:39 ET
Summary
- I believe the sell-down is overdone.
- GPC's US APG segment is still experiencing positive growth, contrary to the headline figures, and the company is addressing market share loss and operational issues.
- I now expect GPC to trade at a modest discount to peers until the headwinds are over.
Summary
Readers may find my previous coverage via this link . My previous rating was a buy, as I believed Genuine Parts Company ( GPC ) should be able to continue growing at mid-single digits as the US APG (Automotive Parts Group) and IPG (Industrial Parts Group) segments continue to recover. I am reiterating my buy rating as I believe the sell-down is overdone. While there are new areas of concern, such as share loss and weakness in field operations, they are not entirely structural or unsolvable. US APG growth remains positive as it exited September, which means growth is still positive, unlike what the headline is reflecting.
Financials / Valuation
Briefly touching on the latest results, GPC reported 3Q23 EPS of $2.49, above consensus estimate of $2.40. Sales grew 2.6% to $5.825 billion, modestly missing consensus estimate of $5.916 billion. Sales growth was mainly driven by a 0.5% increase in comparable sales and 1.7% from acquisitions. Per segment, APG grew 0.6% while IPG grew 0.3%, flattish across both segments.
Based on author's own math
Based on my view of the business, GPC growth in FY23 should be in line with guidance, as 4Q23 US APG growth is still positive (unlike what the headline suggests). Management reiteration of guidance is also proof that 4Q23 growth is going to be in line with 9M23 growth (5.6% revenue growth) in my view. As for FY24, I have toned down my expectations by 100bps to account for the headwinds from share losses and weakness in operations. However, I expect these headwinds to taper in FY24; as such, I leave my growth expectations of 5% the same in FY25. In order to address the headwinds, GPC likely needs to invest resources in marketing to combat share loss and some form of incentive to align operation staffs. Hence, I modestly reduced my margin expectations such that no improvements will be seen in FY24, and FY25 margin expectations are also reduced by the same magnitude (20 bps).
Previously, I discussed that GPC should trade in line with peers like O’Reilly Automotive (ORLY), AutoZone (AZO), and Advance Auto Parts (AAP), given that it has historically traded in line. However, given the new areas of concern (mentioned below), I now expect GPC to trade at a modest discount in FY24 until results show that these headwinds are gone.
Altogether, my target price is now $193, which is still attractive relative to the current share price.
Comments
The stock saw minor upward traction after my last update in late September (roughly 2 months ago), but fell by ~15% post-3Q23 earnings. Based on my review of the earnings, which took me some time, I believe the stock reacted correctly to the headline earnings. However, I think that the sell-down was too much. Below are my thoughts on the US APG segment (the largest part of GPC business), which I believe was the main driver of the sell-down.
The 3Q23 result was not great when compared to the FY22 performance on a headline basis. The segment comparable sales fell 2.9% in the quarter, which was a big delta vs. 3Q22, where it saw a growth of 8% (almost 11pts delta). From a headline basis, this has certainly spooked the market, as the worry is that it might further decelerate in the coming quarters. However, I think the headline figures are misleading. First, there was a 1.7% headwind to the US APG segment's comparable sales because there was one fewer selling day in the quarter, and another 1.7% headwind because it was held at the same time as last year's National Automotive Parts Association Expo, which happens every five years. As such, if we were to adjust for this 340 bps of headwind, US APG comparable sales growth is actually positive. Notably, management also mentioned that US APG sales remain positive in the low-single-digit range as GPC exited September, which means October is likely to see low-single-digit growth as well.
“The average daily sales cadence by month was July slightly up, August down low single digits, and we exited the quarter with September up low single-digits.” Source: 3Q23 earnings
Based on author's own math Based on author's own math
During the quarter, two additional areas of concern were revealed. The first is that US APG is seeing a decline in market share as a result of competition from players like warehouse distributors, who are capitalizing on the improvement in inventory access and the general softening of supply chain headwinds. The second issue was the difficulty in obtaining certain categories of inventory and the reduction in quality of field service. Fortunately, management has put attention to fixing these problems. For the inventory issue, they are looking at alternative suppliers, and for the field service level issue by paying more attention to it. In my opinion, the latter issue is less of a worry as GPC just needs to find other suppliers and improve its operations. While they take time, they are not structural. The former issue is an emerging concern, as it could point to something structural that is hard to fix. That said, GPC has been in the business for decades already. It is not the first time they have seen competition. My take is that this is likely to be a short-term issue as the market share loss is to distributors that now have inventories available to them. In other words, GPC managed to gain share from them because customers had no choice but to purchase from GPC instead of their usual distributors due to a lack of inventories. Now that the distributors have their inventories back, customers are not reverting back to them. Based on my hypothesis, we should see this market share loss narrative taper off over the next few quarters as things normalize.
And as I said, that plus some of the performance of our credible competitors would indicate we've given back some share over the last couple of quarters. But maybe a few thoughts to elaborate on the whole share thought, which is, we've always had strong competition in this profit pool, both large and small.
When you start thinking about and talking about market share, it's a very fragmented industry. Yes, you have the big four, but then you've got independent WDs scattered throughout the country along with others. Source: 3Q23 earnings
Although significantly smaller than APG's US business, I believe that the company's performance in Europe is indicative of GPC's execution and share growth potential. With a 6.8% increase in comparable sales for the quarter, the segment maintained its impressive performance compared to 3Q22's 7% increase. Part of the reason for the impressive growth was that GPC was able to capture market share. Both the US and European markets are fragmented; as such, if GPC can execute in Europe and gain share, I don’t think it is fair to assume GPC cannot do the same in the US (and continue to lose share to smaller players).
Overall, my take is that GPC's weak headline figures have spooked some investors, so the sell-down is not entirely without merit. However, on a like-for-like basis, the narrative is clearly not as bad as the headline suggests, although US APG is still seeing deteriorating sales trends (growth is still in the low single-digits).
Risk & Conclusion
Given the new areas of concern, the risk profile has certainly increased. The major risk here is that GPC continues to face share losses due to structural reasons that are outside of what I expected. This would be a major headwind to US APG comparable sales. Secondly, the problem with operations might be a lot harder to solve if it’s a problem with internal culture. Slow improvements made to operations could hinder growth and result in share losses.
In conclusion, I maintain my buy rating. The recent sell-off seems excessive as the market appears to be worried about the US APG headline figures. The fact is that it is still showing positive growth after making the right adjustments. Concerns about market share loss and operational issues are also being addressed by seeking alternative suppliers and focusing on service quality.
For further details see:
Genuine Parts Company: Remaining Buy Rated Despite New Areas Of Concern