Still, we like the underlying fundamentals of the automotive aftermarket and think the long-term growth trends are sustainable. In mid-September, despite hurricanes and worries about damage to supply channels, oil prices fell below $102 per barrel from the closing high of roughly $145 per barrel on July 14. Consequently, as prices at the pump drop, we should see a favorable impact on miles driven.
New car sales remain under pressure, and it appears that 2008 may experience the lowest level of new vehicle sales in more than a decade. The average age of the vehicle population continues to climb, and with it a higher percentage of critical parts is starting to enter the peak for failure rates. Our sense is that while trends may not be accelerating rapidly for the automotive aftermarket, there has not been any indication of a significant decline in operating performance either. So should these underlying industry fundamentals provide enough comfort for aftermarket participants that business should imminently improve? Probably not.
In fact, we think the challenging operating environment should be viewed opportunistically by participants as a way to implement initiatives — not only from an internal standpoint to drive productivity gains or leaner operations, but also to help strengthen competitive positioning once trends do begin to show some signs of material improvement.
The tough macro backdrop is likely to persist, particularly until the turmoil in the financial sector abates. Back in September, former financial stalwart Lehman Brothers had just filed for bankruptcy protection, and Bank of America had announced its acquisition of securities brokerage giant Merrill Lynch. Our point is that no matter what the true fundamentals may be, perceptions create significant volatility and perhaps have greater impact on investment decisions in this market.
There have been some real differences between Wall Street's "perception" of the automotive aftermarket and actual industry performance in recent months. June quarter results surprised most investors as $4 per gallon of gasoline did not have as dramatic an impact on sales trends and earnings as was anticipated.
Investors reacted favorably to the mostly positive earnings reports, and stock prices for our coverage group have moved higher from June levels. We think one of the biggest factors in the underlying stock price performance has been the steady decline in oil prices. To illustrate, we took a sampling of companies defined as suppliers (Federal-Mogul and Dorman Products) and retailers (Advance Auto, AutoZone and O'Reilly) in our coverage universe that were under pressure with investors fearing declines in miles driven coupled with budgetary constraints from high gas prices would certainly impact second quarter performance.
Interestingly, as Figure 1 shows, from Feb. 19 (last time WTI spot oil prices were actually below $100 per barrel) until July 14 (when WTI spot price closed above $145) the average stock price of the "retailers" declined 0.6 percent, the "suppliers" declined 34.7 percent and the S&P 500 fell 8.9 percent, all at the same time that WTI spot oil prices were up 45.2 percent. Since oil prices last closed above $145 on July 14, shares of many aftermarket companies experienced positive performance — with those of the "retailers" climbing 18 percent and the "suppliers" recording an impressive 54 percent gain versus the S&P 500's modest 1.7 percent increase.
Yet, these large publicly traded companies are not relying on the operating environment to return to levels last seen in 2005. Instead, we continue to hear about initiatives under way to strengthen the supply chain with updated IT platforms or better idle time management for truck fleets. Even software to optimize peak labor staffing has been utilized to gain efficiencies during a softer period for revenues.
While the tendency is to preserve capital during a slowdown, we think a more proactive approach when the operating environment is tough may yield much better results when things actually do improve. For independents and private operators, being mindful of cash flow is prudent, but the ever-changing landscape requires ongoing adjustments and investment to stay ahead of the curve.
Having the most up-to-date equipment, best trained technicians and a supply chain that creates inventory efficiencies as well as cash cycling times can help drive stronger financial results, even when the environment is challenging.
Remember, as Jack Dempsey used to say, sometimes the "best defense is a good offense." So when out at AAPEX or SEMA, certainly keep current operations a focus, but be mindful of opportunities that can set you apart from the competition.
Whether or not the changes in consumer spending patterns and driving habits have created structural changes to the aftermarket remains to be seen, but taking advantage of difficult situations should allow for adequate preparedness regardless of the automotive aftermarket's evolution in the coming years.
BB&T Capital Markets is a full-service investment banking firm that focuses on specific industries, including the Automotive Aftermarket industry. BB&T Capital Markets is a division of Scott & Stringfellow, Inc., NYSE/SIPC. Scott & Stringfellow is a registered broker/dealer subsidiary of BB&T Corporation, one of the nation's largest financial holding companies with $136.5 billion in assets.
Disclosures: BB&T Capital Markets makes a market in the securities of Dorman Products, Inc. and O'Reilly Automotive Inc.
BB&T Capital Markets has managed or co-managed a public offering of securities for AutoZone, Inc. in the last 12 months.
BB&T Capital Markets has received compensation for investment banking services from AutoZone, 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.; AutoZone, Inc.; Dorman Products, 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, Advance Auto Parts, Inc. for such services.
An affiliate of BB&T Capital Markets received compensation from Advance Auto Parts, Inc.; AutoZone, Inc.; and O'Reilly Automotive Inc. for products or services other than investment banking services during the past 12 months.
