Ready for Graduation Day: Advance Auto Parts
Keith is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
It’s the time of year for graduations. High school seniors are preparing to leave their youth behind and move to adulthood. College seniors are hoping to enter the world of work. Even kindergarteners are graduating, ready for that last summer before going to big kids' school. I think there are a handful of companies ready to graduate also. These companies are very successful but have not advanced to the big league of stocks yet -- inclusion on the S&P 500 Index.
Just like colleges and employers have criteria for selecting from the graduate pool, S&P focuses on specific criteria. In particular, they look at trading analysis, liquidity, ownership, fundamental analysis, market capitalization, and sector representation. The trading analysis and liquidity criteria basically involve ensuring that stocks trade at a reasonably high volume. By ownership, S&P means that there is a sufficient float so that shares are available for investors to purchase.
S&P’s fundamental analysis hurdle isn’t too hard to achieve. They require companies to have four quarters of positive net income (with special consideration for companies that would have been profitable except for a merger or acquisition). There isn’t a hard cut-off level for market cap size, but S&P typically looks to include companies valued at least $4 billion. Sector representation involves ensuring that the mix of companies for each industry sector in the S&P 500 Index roughly matches the sector weight in the universe of stocks.
All of the companies on my short list meet S&P’s criteria, although some are in sectors already well-represented in the index. The first of these graduation candidates we will examine is Advance Auto Parts (NYSE: AAP). The others will be discussed in future posts.
Activities & Honors
Advance Auto Parts is a leading specialty retailer of automotive aftermarket parts, accessories, batteries and maintenance items. The company operates nearly 3,500 stores in 39 U.S. states and in Puerto Rico and the Virgin Islands. Commercial sales account for around 34% of 2011 sales with the bulk of sales focusing on the retail consumer “do-it-yourself” (DIY) market. AAP’s growth is largely in the commercial line of business. The company expects to grow to a 50/50 sales mix between commercial and DIY over the next few years.
The aftermarket auto parts industry has benefited from the trend for Americans to keep their cars longer than ever before. The average age of the 240 million vehicles on the road in the U.S. is 11 years. Nearly two-thirds of those are over 7 years old. These statistics translate to significant growth in the auto parts market.
AAP competes against large chains including AutoZone (NYSE: AZO), O’Reilly Automotive (NASDAQ: ORLY) and Pep Boys - Manny, Moe & Jack (NYSE: PBY), as well as smaller parts stores. AutoZone and O’Reilly are the strongest competitors. Along with AAP, these two stocks have enjoyed great runs over the past three years. AutoZone and O’Reilly both are already listed in the S&P 500 Index.
While it’s not yet in S&P’s 500, AAP is on two 500 lists - the Fortune 500 and Barron's 500. The company ranked number 392 on the most recent Fortune 500, a little behind AutoZone (number 320) but ahead of rival O’Reilly (number 424). It scored even higher on Barron’s ranking, coming in at number 102. Barron’s ranked AutoZone at number 75 and O’Reilly at number 172.
One way AAP is winning for investors is by improving its supply chain. The company uses sophisticated logistics and inventory management technology. It currently has eight distribution centers across the country but is rolling out another center in 2012. What difference do the supply chain improvements make? Take a look at the chart below:
While the number of stores has grown by around 12% over the last four years, AAP has experienced a significantly higher level of growth in its earnings per diluted share. The company has aggressively wrung increasing profits out of its existing stores while incrementally adding new stores. The supply chain innovations have been a major factor in this success.
Unlike in high school and college, we don’t have a single number like GPA to review for Advance Auto Parts. AAP does have some solid numbers to look at, though, as do some of its peers.
None of these matter for inclusion on the S&P 500 Index, but they do matter to investors. AAP’s forward P/E of slightly over 13 looks good considering its P/E ratio has ranged between 10 and 19 over the past five years. The company has a strong return on capital and a solid free cash flow. These numbers compare favorably against the S&P 500 Index averages of 13.4 forward P/E and 11.5% return on capital.
I don’t know if AAP will be added to the S&P 500 Index in the near future. Over 100 companies in the index have lower market caps than AAP, though. There are also many in the index that are not as strong as AAP. However, the retail sector is well-represented in the S&P 500 index and the two larger auto parts companies are already in the index.
Regardless of whether or not AAP gets picked at some point by S&P, the stock deserves consideration by investors. With good fundamentals, solid execution and potential for growth, Advance Auto Parts could be a feather in an investor’s cap - and maybe in the gown, too.
Keith Speights has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.