The Perfect Stock to Own for Another Recession
Ted is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Uncertainty in Washington, and rumors of the Fed lifting interest rates in the later part of 2013, could push the United States back into a recession. For many investors, this is a signal to get out of the stock market. However, some companies may actually benefit from lower economic activity. One such company is Advance Auto Parts (NYSE: AAP).
Advance Auto Parts' products are largely non-discretionary, meaning consumers must buy them whether they want to or not. Recessions are particularly good for aftermarket auto parts, because fewer people buy new cars during a recession, which means more people own old cars that need new parts. As a result, Advance Auto Parts and its peers were able to continue growing even during the Great Recession. This, in combination with attractive economics, makes Advance Auto Parts a good bet for a new recession.
In the auto parts business, companies with superior scale are best-positioned to dominate the industry. Advance Auto Parts has lower revenue than AutoZone (NYSE: AZO), but higher revenue than O'Reilly Automotive (NASDAQ: ORLY) and Pep Boys (NYSE: PBY).
Despite having similar revenues as O'Reilly Automotive, Advance Auto Parts earns a consistently lower operating margin.
This is because Advance has a higher cost structure than Autozone and O'Reilly. But management is working diligently to lower its costs. Management has provided a target operating margin of 12%, which is 1.2 percentage points higher than its 2011 operating margin.
In addition to slashing spending on SG&A, Advance can reach its 12% operating margin by continuing its expansion westward across the United States. Although the vast majority of its stores are located in the Eastern part of the United States, the company says that its stores in the Western part of the country are far more profitable than those in the East. Therefore, further expansion into the more profitable Western geographies will enable the company to reach its profitability goals.
The company has also made significant investments in its commercial segment. The commercial segment has different economics than the company's traditional do-it-yourself segment, and it is still unclear as to how much value will be added by expanding into this new terrain. However, a successful foray into the commercial auto parts business will solidify Advance Auto Parts as one of the top companies in the industry.
The most important component of the investment equation is the price investors must pay. Advance Auto Parts trades at a lower price-to-earnings, a lower price-to-free cash flow, and a lower enterprise value-to-EBITDA than its peers.
In addition, the company trades at just 10 times historical pre-tax earnings, assuming the company earns a similar pre-tax margin on current revenues as it has on past revenues.
However, the investment looks most attractive when you assume that the company will meet its operating margin target of 12%. If you apply that target margin to trailing-12-month revenue, you get a $744 million operating profit. At 10 times this figure, the company is worth $101 per share before any growth in revenues is accounted for. This presents significant upside from the company's recent stock price of $73.62 per share.
Advance Auto Parts is an attractive investment if you believe the United States is headed for another recession. In addition, you must believe that management can hit its cost target, and that it will not destroy value with its investments in the commercial segment. If the company is able to do well in the commercial segment, it may soon dominate its industry. In that case, Advance Auto Parts is a steal at today's stock price.
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