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.
While payrolls are improving and disposable income continues to grind higher, these advances will be insufficient to offset the budgetary encroachment felt by consumers should petroleum prices maintain their current trajectory. This in turn does not bode well for the aftermarket, nor the broader consumer landscape, as motorists are likely to revisit their driving levels in order to restore a more normal weighting, approximately 3 to 3.5 percent, of fuel expenditures relative to income.
As the spike in crude oil and gasoline prices is primarily a function of mounting concerns over potential supply disruptions in the Middle East, visibility remains limited as to when and to what extent the current “risk” premium on oil prices abates. So while gasoline prices in the mid-$3 range may not elicit the same degree of sticker shock at the pump as was experienced in 2008, with many consumers still uncertain as to the health of the broader economy, further increases — we think $4 may be the tipping point — are likely to constrain aftermarket demand levels in what is normally the seasonally strongest time of the year.
As challenging as it is to find fault with the solid results that our aftermarket coverage group has posted, it is also difficult to overlook the recent spike in gas prices, and the fact that these companies will face more challenging SSS comparisons in coming quarters. In our opinion, the real challenge for aftermarket equity performance at this point in time lies in attracting incremental buyers.
Overall, we get the sense that most investors are content to wait for these stocks to get cheaper and see little in the way of near-term catalysts to spur material price appreciation from current levels. In our view, for the shares to move higher we need to see 1) confirmation that March and April sales trends have held up in the face of tough comparisons from last year, and 2) stabilization in gasoline prices and miles driven (last data point was +0.6 percent year over year in December, prior to the spike in fuel costs), that will in turn 3) prevent downward pressure on consumer spending on automotive maintenance and repair.
About BB&T Capital Markets:
BB&T Capital Markets is a full-service investment banking firm that focuses on specific industries, including the Automotive Aftermarket. BB&T Capital Markets is a division of Scott & Stringfellow, LLC, member NYSE/FINRA/SIPC. Scott & Stringfellow is a wholly-owned nonbank subsidiary of BB&T Corporation, one of the nation’s largest financial holding companies with $155 billion in assets. Securities and insurance products or annuities sold, offered or recommended by Scott & Stringfellow are not a deposit, not FDIC insured, not guaranteed by a bank, not insured by any federal agency and may lose value.
Disclosures:
BB&T Capital Markets makes a market in the securities of Advance Auto Parts, Inc. and O’Reilly Automotive Inc.
BB&T Capital Markets has managed or co-managed a public offering of securities for Advance Auto Parts, Inc. and O’Reilly Automotive Inc. in the last 12 months.
BB&T Capital Markets has received compensation for investment banking services from Advance Auto Parts, Inc. and O’Reilly Automotive Inc. in the last 12 months.
BB&T Capital Markets expects to receive or intends to seek compensation for investment banking services from Advance Auto Parts, Inc. and O’Reilly Automotive Inc. in the next three months.
Advance Auto Parts, Inc. is or during the past 12 months was a client of BB&T Capital Markets, which provided non investment banking, securities-related services to, and received compensation from, the aforementioned company for such services. The analyst or employees of BB&T Capital Markets with the ability to influence the substance of this report know the foregoing facts.
An affiliate of BB&T Capital Markets received compensation from Advance Auto Parts, Inc. and O’Reilly Automotive Inc. for products or services other than investment banking services during the past 12 months. The analyst or employees of BB&T Capital Markets with the ability to influence the substance of this report know or have reason to know the foregoing facts.
