Auto Parts Retailers An Attractive Segment To Invest

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Mar 17, 2015

Stocks of major auto parts retailers, with the exception of Pep Boys (PBY, Financial) have been on the upswing since the last quarter of 2014 due to a combination of factors and given current trends; the auto parts sector presents an attractive buying segment despite the current elevated levels. A reviving economy, lower unemployment and even lower fuel prices are all contributing to people driving more than they have been for the last few years, and this is good news for the auto parts retail businesses like AutoZone (AZO, Financial), O’Reilly Automotive (ORLY, Financial) and Advance Auto Parts (AAP, Financial).

The oil factor

With an improving economy and more people coming out of unemployment, there is an increase in customer spending pattern. Combined with oil prices that are languishing near historic lows, people are encouraged to drive more. According to data from the Transportation Department, Americans drove more miles in December 2014 than they did in December 2013. This was a turnaround for the first time since 2008, when a combination of the financial crisis, rising oil prices and unemployment above 10% cut short the usual annual trend of increasing vehicle miles. As per the Transportation Department data, miles driven in each of the last 2 months of 2015 was higher than the corresponding months in 2014, an encouraging sign that a sustainable trend might be settling in place.

An ageing fleet

According to a study by IHS’s (IHS, Financial) automotive division, the combined average age of all light vehicles on the road in the U.S. at the beginning of 2015 is 11.4 years, the same as it was the year before, which is the oldest it has ever been. The same study goes on to say that due to improved quality of cars (which are now made to last longer) and with consumers holding on to their vehicles for longer (due to lingering economic uncertainties), vehicles older than 12 years will continue to grow in number and are expected to increase by 15% by 2019. This will lead to more repairs and parts replacement being needed, especially for the older vehicles, and that in turn will mean brisker business for auto parts retailers.

Industry consolidation

Auto parts retailers such as AutoZone, O’Reilly and Advance Auto Parts have been consolidating the industry, taking market share away from the mom-and-pop stores and in the process, have increased their negotiating power with a very fragmented vendor base, says Robert Higginbotham, analyst at SunTrust Robinson Humphrey. “With long payment terms from their vendors, these companies have been able to fund inventory at almost zero cost, which allows them to take even more share from the mom-and-pops,” he says. “That has driven big gains in margin and working capital,” both of which help stock performance.

Other factors

All the three companies being discussed have built fairly large distribution networks and have a retail presence across most of the U.S. More stores are being opened on a regular basis, and AutoZone is looking to expand operations in Mexico and Brazil. These companies are also acquiring smaller companies to further consolidate the market and expand their own presence across the U.S. More importantly, they are all quite aggressive in share buybacks, thus adding value to their shareholders’ portfolios. And that is what shareholders care the most about.