Advance Auto Parts (AAP) is well-positioned to gain from the new normal

While the change in people’s travel patterns and spending-cuts impacted new vehicle sales during the pandemic days the used car market witnessed a boom, which is having a positive effect on the business of aftermarket parts providers like Advance Auto Parts, Inc. (NYSE: AAP) also.

Advance Auto Parts’ resilience to the ongoing crisis underscores its ability to create shareholder value. However, the company’s decision to withhold the full-year guidance does not seem to have gone well with investors. The bearish sentiment, combined with the relatively high COVID-related costs, had a negative impact on the stock this week, despite strong third-quarter results.

A Promising Stock

But experts have an optimist view as far as the stock’s future prospects are concerned, with their target price indicating a 13% upside. Given the strong fundamentals, the stock will bounce back even if it falls further. While the dividend yield is not very impressive, the company has been repurchasing shares consistently.

The executives will tend to adopt a conservative stance in capital spending, considering the need to preserve cash. Going forward, the consolidation of back-office systems, streamlining of real estate footprint, and reduced travel spend should enhance cost-efficiency, thereby adding to margin growth.

Our disciplined approach to managing our balance sheet has allowed us to take advantage of the current low interest rate environment, resulting in a stronger debt maturity profile and improved leverage ratio. We believe our debt financing initiatives have further safeguarded the business for the future.

Jeff Shepherd, chief financial officer of Advance Auto Parts

DIY Boom

In the last few months, the company’s do-it-yourself omnichannel witnessed a spike in traffic as customers sought to have repairs and maintenance done without the help of technicians. Also, there is speculation that the demand for spare parts and repairs would remain high since most owners would choose to continue using their old vehicles due to the macroeconomic uncertainties and weakness in the job market.

Related: GM bets on SUVs, EV to emerge stronger from COVID

The pandemic-driven increase in the demand for used vehicles also bodes well for spare parts providers because aging vehicles need more maintenance than new ones. Meanwhile, there is uncertainty over the sustainability of the demand trend, given the sharp decline in miles driven due to the movement restrictions.

Comps Surge

The highlight of the company’s third-quarter report was the continuing recovery of comparable sales, which grew at a faster rate of 10.2% compared to last quarter and improved sharply from the negative growth seen in the early months of the fiscal year. Net sales rose 10% annually to $2.5 billion, driving up adjusted earnings by 34% to $2.81 per share.

Commenting on the current quarter, chief executive officer Tom Greco said, “As a reminder, Q4 tends to be our most volatile quarter each year, primarily due to fluctuations in weather. In addition, we remain sensitive to potential volatility from other external factors in the current environment, particularly those related to the future spread of COVID, and the possibility of heightened stay-at-home orders in the near term.”

Peer Performance

A few weeks ago, rival company Autozone (AZO) surprised everyone by reporting a whopping 22% growth in comparable-store sales for its fourth quarter, marking a strong recovery from the lows seen in the previous quarters. The upturn reflected in the company’s sales and bottom-line also. Interestingly, in the post-earnings session, Autozone’s stock suffered the same fate as Advance Auto Parts.

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Read management/analysts’ comments on Advance Auto’s Q3 results

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The market’s response to Advance Auto Parts’ stronger-than-expected results was not very encouraging. The stock suffered soon after the announcement but regained most of the lost momentum later. Earlier, the shares recovered quickly from the weakness seen soon after the virus outbreak. Currently, they are trading close to the pre-crisis levels.