Why This Dip in Advanced Auto Parts May be an Opportunity

Aug 27, 2022 at 1:01 AM
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    Why This Dip in Advanced Auto Parts May be an Opportunity

    Shares of Advance Auto Parts (NYSE: AAP) gapped down after – wait for it – the company lowered its guidance for the rest of the year. The company is seeing uncertain demand, particularly for its DIY customers as inflation continues to have consumers delay discretionary purchases.  

    It didn’t help that the auto parts retailer reported earnings on what was bound to be a volatile week for equities. Sure enough, as I write this article, AAP stock is down over 13% for the week. This is putting the stock within 10% of its 52-week low that it reached in June 2022.  

    We don’t advocate market timing, so I’ll simply acknowledge that AAP stock may have further to fall. But if you’re willing to take a long position, there are signs that Advance Auto Parts may present investors with an opportunity.  

    Demand is Likely to Remain Steady 

    The latest economic data shows that new car prices continue to rise on a year-over-year basis. On the one hand this shows that pent-up demand for vehicles of all sorts is still strong. But there are several reasons why this only tells part of the story.  

    • Rising prices for new cars will make a new car unattainable for individuals below a certain income threshold.  
    • Used car prices, though off their peak, remain at historically high levels. 
    • Rising interest rates will make the price of financing a car less attractive and may, in fact, price lower income individuals out of the market.  

    The takeaway is that many customers have financial incentives to hang on to, and maintain, their existing vehicle.  

    Delivering Parts at the Right Time 

    That brings up another point. The vehicles of today are becoming increasingly more complicated for the do-it-yourselfer to repair by themselves. However, Advance Auto Parts also does a brisk business with professional installers. And the company’s growing footprint makes the company an option for these businesses to get the parts they need in a timely fashion, often in the same day.  

    What drives this point home even more is that the company continues to open new locations. The company announced it has opened 78 new stores through the second quarter. That is keeping the company on track to meet its goal of opening between 125 to 150 stores in 2022.  

    Analysts are Lowering Their Price Targets, But … 

    Like clockwork, the analyst community began lowering their price targets for AAP stock after the company lowered its forecast. But all the price targets are still well above the stock’s current price. In fact, the analysts tracked by MarketBeat give AAP stock a consensus price target of $235 which is a 33% upside from its current level.  

    And even if AAP stock doesn’t climb that high, investors can still take advantage of a juicy dividend. The yield is up to 3.40% and the yearly payout calculates to $6 per share on an annual basis. Supporting the dividend is the company’s free cash flow (FCF). FCF was down 84% year-over-year in the first half. However, the last two years are probably outliers in terms of the company’s free cash flow. And the company expects that number to improve in the second half of the year.  

    AAP Stock is a Solid Choice for Value Investors

    At a price of around $176 as of this writing, AAP stock has a forward price-to-earnings ratio of 11.78 which suggests the stock may be undervalued. The company’s core DIY customers may still face headwinds from inflation and a slowing economy into 2023. However, investors that are willing to take a long position can benefit from a company that is expanding and showing strong operating margins. Add in a juicy dividend and the stock looks like a strong choice for value investors.  

     

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