- Advanced Auto Parts is down over 15% after delivering poor results on its bottom line
- Analysts have been quick to downgrade AAP stock on concerns about demand in a weakening economy
- The company is making investments in its supply chain to ensure that this quarter is an outlier to what has been a bullish story
- Investors should wait for more clarity before taking a position in AAP stock
Advance Auto Parts (NYSE:AAP) is down more than 15% after missing badly on the bottom line in its third-quarter earnings report. The company’s revenue of $2.64 billion came in roughly in-line with expectations. But on the bottom line, analysts were expecting $3.40 of earnings per share (EPS). The company, however, delivered just $2.84 EPS.
Furthermore, the company lowered its outlook for the full year. The company is now guiding for EPS in a range of $12.60 to $12.80 down from its prior guidance for $12.75 to $13.25.
Analysts reacted swiftly with over a half-dozen analysts either lowering their rating, lowering their price target or both. The question that investors must ask is whether the sell-off is overdone? Advance Auto Parts did have that misfortune of reporting on the same day when Target (NYSE: TGT) delivered a poor earnings report with a dismal outlook for the holiday season.
A One-Off or the Reversal of a Bullish Trend?
In 2021, Advance Auto Parts announced three goals: growing sales, expanding margins, and returning money to shareholders. Prior to this earnings report, the company was doing just that, and quite successfully.
The inflated cost of new and used cars was a tailwind for auto parts stores in 2021. Consumers were looking to keep their existing car in good working order just a little longer. One concern heading into 2022 was whether these companies could keep that momentum. However, in 2022, Advanced Auto Parts has kept its revenue consistent on a year-over-year (YOY) basis.
That trend continued in this quarter. What didn’t continue to grow were the company’s margins. They contracted for the first time in nine quarters. Inflation, in this case, was a double-edged sword that hurt the company’s margins.
Tom Greco president and CEO, said the company is taking steps to ensure it has the right inventory in place. A key initiative that the company is taking is to increase the inventory of its house brands which have lower costs for the consumer and higher margins for the company.
However, this investment hit the company’s free cash flow (FCF) projections. Advance Auto Parts now expects to achieve $300 million in FCF down from prior estimates of $700 million.
More Customers or More Sales Per Customer?
This is the question that investors will need to reconcile as it relates to an investment in AAP stock. In lowering their outlook for AAP stock, analysts expressed concerns that the company’s earnings decline was evidence of losing customers.
That would take the company into a bearish spiral as new customers may be hard to find in a recession. On the other hand, Greco says the issue is not so much about new customers as generating more sales per customer. In an interview with CNBC, Greco argued that the company’s customer base, which consists of professionals as well as do-it-yourselfers, has never been particularly loyal to one auto parts store.
Greco’s belief is that their investment in ensuring the company has the right products, at the right locations, at the right times will pay off.
Should You Buy AAP Stock on the Dip?
Before the earnings report, AAP stock was trading in a range between its 50- and 200-day moving average, with the 200-day SMA providing firm resistance. It’s sliced well below the 50-day SMA now. But strictly from a technical standpoint, AAP stock looks oversold right now.
However, I’m writing this less than 24 hours after the company’s earnings report. For certain, the consensus price target of $235 put forth by the analysts surveyed by MarketBeat is going to come down. And that will be when investors can figure out how high the ceiling will be for AAP stock.
In the meantime, if you were (or still are) a shareholder, the company will pay its current dividend of $1.50 per share. The company has been increasing this dividend at impressive levels since 2020. You shouldn’t expect that level of growth to continue. But with an annual dividend of $6.00 per share, it could be worthwhile for income investors to hang on to their shares.