RS Investments Comments on AAP
Advance Auto Parts (NYSE:AAP) is the second largest auto parts retailer in the U.S. operating over 3,600 stores in 39 states. The company sells primarily non-discretionary automotive parts such as car batteries, brake pads, spark plugs, and mufflers to both do-it-yourself customers as well as commercial garages via its parts-delivery truck service. Our investment in Advanced Auto Parts was predicated on the following thesis: (1) solid industry fundamentals with acyclical demand drivers, defensible competitive positioning, and reasonable reinvestments opportunities; (2) a companyspecific opportunity to meaningfully improve the Company's financial performance as measured by sales productivity, operating margins, asset turns, and overall Return on Invested Capital (ROIC) relative to its two primary competitors (AutoZone and O'Reilly); and (3) a new leadership team with a solid business plan for narrowing this performance gap.
At the time of our initial investment in 2007, Advanced Auto Parts was operating with sales-persquare- foot of $180, operating margins of 8.5%, a payables-to-inventory ratio of 50%, and was generating reinvestment cash flow of approximately $280 million on an invested capital base of $1.6 billion. Through successful implementation of a wide variety of operating initiatives, including greater parts availability, enhanced price optimization, better vendor terms, and improved labor productivity, CEO Darren Jackson and his team meaningfully improved the financial performance of the company. Today, Advanced Auto Parts operates with sales of $230 per foot, operating margins approaching 11%, a payables-to-inventory ratio of 80%, and is generating reinvestment cash flows of approximately $460 million on a reduced invested capital base of $1.4 billion. Overall company ROIC has improved from 13-14% in 2007 to approximately 20% today. Advanced Auto Parts' share price has tracked this improvement in ROIC, appreciating from a stock that traded in the high $30s at the time of our initial investment to $90 per share more recently. Over the past five years we have both added to and trimmed our position size, depending on the relative risk/reward in the market, and we ultimately exited the position at the beginning of the second quarter at a substantial gain.