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Robert Stephens, CFA
Robert Stephens, CFA
Articles (157) 

Why Advance Auto Parts Could Surge Higher After Recent Gains

The company has the right growth strategy

March 21, 2019 | About:

Auto parts retailer Advance Auto Parts Inc. (NYSE:AAP) could deliver further stock price growth after rising 47% over the past year.

The company is implementing a revised strategy that will see it invest increasingly in its omnichannel offering as well as in a variety of new products. This could improve its competitive advantage and boost customer engagement levels. It is also making changes to its stores to improve efficiency and offset potential cost increases. A retail partnership with Walmart Inc. (NYSE:WMT) could provide cross-selling opportunities.

With the company expected to post improving profit growth next year, the stock could offer good value. Further outperformance of the S&P 500 may be ahead.

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Investing for growth

The company continues to invest in its omnichannel capabilities. In doing so, it is aiming to improve online engagement and fulfillment, which could enhance the customer experience. To achieve this goal, it is boosting the page load speed on its website and beefing up search capabilities through increased customization based on factors such as a customer’s vehicle and search inputs. This helps to increase consumer confidence with regard to receiving the right product. An increased use of artificial intelligence and machine learning tools is also set to improve cross-selling opportunities through the website.

Advance Auto is also investing in a variety of new products to beef up its competitive advantage. For example, it recently launched its unified professional portal, MyAdvance, which integrates a range of online tools in one easily accessible location. This has contributed to a 50% increase in usage of the platform, providing increased differentiation versus rivals.

Retail strategy

Advance Auto Parts is making significant changes to its store estate. It opened 14 new Worldpac branches in fiscal 2018, while closing 101 underperforming stores. Additional store openings are expected in fiscal 2019 as the company seeks to improve its value proposition, while store closures could help to boost its overall efficiency. The company is also optimizing its distribution centers, having closed its Gallman and San Antonio distribution centers in fiscal 2018. It plans to close its Columbia distribution center in 2019, which could further streamline operations.

The recently announced partnership with Walmart is set to expand the company’s reach to do-it-yourself customers and help drive market share growth. So far, the partnership has had a strong start, delivering an improving value proposition for customers. Future relationships with major retailers could follow over the medium term, offering a relatively favorable risk-reward opportunity for the business.

Risks

The company’s costs have been rising at a relatively fast pace in recent months. In the most recent quarter, it reported selling, general and administrative costs as a percentage of sales increased 82 basis points to 38.1%. Advance Auto attributed this performance, in part, to an increase in last mile delivery expenses, which were higher due to increased fuel and transportation expenses. Although the business has been able to pass on higher tariff-related costs to customers in the form of higher prices so far, continued protectionist policies could be detrimental to its margins over the medium term.

In response to higher costs, Advance Auto Parts is seeking to improve its efficiency and streamline its supply chain. As part of this initiative, it is increasing transparency and collaboration between the supply chain and other functions, such as store operations and merchandising. It is also putting in place new tools and technology, such as its delivery dashboard, which helps to improve the reliability of its delivery through the use of telematics. This will be complemented by an enterprise resource planning project that will integrate its various back-office systems over the next two years.

Outlook

Advance Auto Parts is making major changes to its strategy. It is seeking to develop its omnichannel offering in order to strengthen the customer experience. It is also improving the performance of its stores, while investing in a variety of products to increase its competitive advantage. Retail partnerships could also boost its financial outlook.

The company is projected to post 16% growth in earnings per share in the next fiscal year. Although it faces risks from higher costs, Advance Auto's efficiency program could improve its financial performance over the long run.

After surging 47% over the last year, the stock could continue to outperform the S&P 500. The stock offers a favorable risk-reward ratio given the potential impact of the company's evolving strategy.

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