Friday, June 9Welcome

3 red flags waving to advance auto parts inventory

Something’s wrong with the auto parts retailer advance auto parts (AAP 1.14%), stocks are worth avoiding until the company corrects its policy. This article highlights some charts dating back to when activist hedge fund Starboard Value announced its investment in the company (September 2015), and goes further on key metrics to monitor the company. I will explain.

Original case for purchasing Advance Auto Parts

This was the classic value investing argument of 2015, and arguably still the case today. The idea is that Advance is an operational metric, so it clearly lags behind its closest peers. O’Reilly Automotive (Orly 0.14%) When auto zone (Azo 0.73%)all the company needs to do is improve its business to be similar to its rivals in order to create greater value for its investors.

Advance Auto Parts continues to lag behind peers

Unfortunately, the story told in the price chart below shows that the company is still far from achieving that goal.

AAP chart

Data from YCharts.

It’s not hard to see why. Advanced Auto Parts’ profit margins and free cash flow generation (shown here as a percentage of assets) are far from peers.

AAP Operating Margin (TTM) Chart

Data from YCharts.

How Starboard planned to improve operational performance

For clarity, Starboard is no longer an auto parts retailer. And it’s hard to argue that the activist firm’s opinion (Starboard CEO Jeffrey Smith, who served on the board of Advance Auto Parts from 2015 until 2020) actually improved the company’s performance.

When Starboard first got involved, there was great hope that the auto parts retailer’s profitability and cash flow would improve through reorganization of its supply chain, distribution and inventory management. In a nutshell, Starboard wanted Advance to get more products to stores faster. This has led to customers, especially professionals serving the do-it-yourself market, becoming regular and loyal shoppers.

At the same time, Starboard wanted Advance Auto to improve its working capital requirements by increasing its accounts payable to inventory ratio. This is simply a matter of how much you owe your suppliers (more accounts payable means more cash Advance Auto holds) and inventory (more inventory means more cash is tied to goods). ratio). Therefore, a higher accounts payable inventory count is often desirable.

what happened

Unfortunately, Advance Auto is far behind.

This is the accounts payable-to-inventory ratio for the three major auto parts retail chains and shows how cars are lagging behind the group.

fundamental chart chart

Data from YCharts.

And it gets worse. Now let’s look at the accounts receivable turnover ratio. This is sales divided by average accounts receivable. Therefore, the higher the number, the better the company is at collecting receivables on sales. This is not an area Advanced Auto is good at.

AAP Accounts Receivable Turnover (TTM) Chart

Data from YCharts.

Finally, let’s look at the inventory days open (the average number of days a company holds inventory before selling it; the lower this number, the better). Again, Advance Auto has not significantly improved his performance dating back to late 2015.

AAP Daily Inventory Open (Yearly) Chart

Data from YCharts.

What’s next for Advanced Auto Parts?

Given such lagging metrics, it’s no surprise that the company’s latest earnings report once again lags behind O’Reilly and AutoZone. Meanwhile, seven years after Starboard’s initial involvement, Advance Auto’s CFO Jeff Shepherd said on the earnings call that “bringing more parts closer to our customers is our number one priority,” adding, “To improve inventory. of strategic inventory investments. This is the primary driver of the decrease in free cash flow guidance. ”

A familiar playbook, but until Advance Auto begins to show significant improvements in inventory management, debt collection, or accounts payable management, as previously mentioned, these ongoing red flags should give investors confidence. It will be difficult to purchase shares with

Lee Samaha has no positions in any of the mentioned stocks. The Motley Fool has no positions in any of the companies mentioned. The Motley Fool’s U.S. headquarters has a disclosure policy.

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