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Sales battle weather challenges

Tuesday, March 29, 2011 - 00:00

As we exit another earnings season, results were largely in line with expectations as almost every aftermarket company we follow posted very strong results. Consistent were discussions centered on continued strong demand into December that surprised most investors given the general volatility of consumers around the holidays. But as you know, the market is a discounting mechanism, and recent moves in the shares had already reflected this good news with investors, instead turning their focus towards recent bouts of inclement weather.

While no management team likes to use rain or snow as an explanatory crutch, winter weather has been extreme, with some parts of the Northeast buffeted by 6 consecutive weeks of snowstorms. The message provided by those public companies that reported in February, such as Advance Auto Parts and O’Reilly, was clear in that winter weather had kept the first quarter off to a very slow start. Although the fact that inclement weather could constrain sales is understandable, investors still get concerned, and to a degree less enthusiastic, about an investment when trends start to slow, even if fundamentals are still strong.

For example, Advance Auto posted strong Q4’10 same store sales (SSS) of +8.9 percent, then gave 2011 guidance for flat to low single-digit comp growth based on current trends. O’Reilly (ORLY) fared a bit better, reporting fourth quarter SSS growth of +9.2 percent, with guidance decelerating more moderately to +3 percent to 5 percent for 2011. ORLY also has less exposure to the Northeast than AAP. Overall, company guidance has set expectations for low-mid single digit SSS growth in 2011, which in our opinion is conservative, but still implies that underlying fundamentals remain strong. As a result, the shares had largely remained in a holding pattern as investors weighed the risk/reward opportunity for this group given its very strong outperformance over the past couple years.

Unfortunately, the investment decision for aftermarket stocks has been further complicated since late February as a result of the spike in crude oil and gasoline prices following social and political instability in the Middle East. According to the U.S. Energy Information Administration, the current national average for gasoline prices is $3.52 /gallon (as of 3/07/11) – an increase of $0.50 since the beginning of the year. While we believe that consumers have become somewhat more accustomed to elevated — and volatile — gasoline prices following the surge seen in 2008, we are concerned about the potential for further price escalation in coming months as miles driven and fuel consumption seasonally peak.

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