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Impact of pain at the pump

Monday, May 16, 2011 - 00:00

In recent weeks, we have become increasingly concerned over the potential impacts of higher gasoline prices on aftermarket demand trends, given the meteoric rise of crude oil prices (from less than $90 a barrel in January to a close of $113 on 4/8/11, when this article was written.)

First, as gasoline prices move well above 3.5 percent of disposable personal income, history shows that consumers begin to revisit their driving patterns in an attempt to rebalance their budgets, leading to slowing, and even declining, miles driven. Based on the 4/8/11 national average gasoline price of $3.68 per gallon, we estimate that fuel expenditures are currently running at 4.2 percent of disposable income. And given that the distance a vehicle travels is a primary determinant of future maintenance and repair needs, all else being equal, this rebalancing process does not bode well for future aftermarket sales trends. Second, until consumers are able to adjust their driving habits such that fuel expenditures are brought back in line with historical averages, or conversely, fuel prices decline, aftermarket sales trends slow as consumers defer maintenance and repair expenditures to the extent possible. Given that car payments and insurance outlays are generally fixed in the short-intermediate term.

Conversations with numerous industry contacts suggest that sales bounced back in February and early March following what was a soft January — likely weather related — but that sales have softened noticeably through the latter part of March and into April to date. Our sense is that on average, same store sales (SSS) are currently running +/- flattish on a year over year basis, with commercial sales holding up somewhat better than DIY trends, given a relatively more affluent customer base.

While we expect Q1 2011 results will likely come more or less in line with current consensus forecasts, we believe that company outlooks and guidance are likely to be negatively biased, given what seem to us to be decelerating trends to date in Q2. At this point, we simply believe that the rapidity of the spike in fuel prices — and not to mention other budgetary drags such as food inflation — are likely to more than outweigh the favorable secular tailwinds provided by the aging of the fleet. While conditions in the Middle East could calm and oil prices may retreat from their current highs, at this point, pains at the pump appear to be impacting consumer buying patterns for auto aftermarket parts and service.

The retailers and distributors, such as Advance Auto Parts, Inc., AutoZone, Inc. and O’Reilly Automotive, Inc. are likely to feel the impact first given the greater “tax” of higher fuel expenses on their core customer base, and should also experience greater distribution expenses to their commercial customers. Next in line are the service providers such as Midas, Monroe and Pep Boys. While a typically more affluent customer base provides relatively better insulation, these companies are also likely to see sales slow; in addition, higher oil prices create margin pressures in both the oil change and tire categories.

The suppliers, such as Dorman Products, Motorcar Parts of America and SMP Auto Parts, are also likely to experience some slow down in their business, although the impact on reported results is likely to be lagged as their customers gradually cut back on replacement orders should inventory levels build. Federal-Mogul and Cooper Tire & Rubber Company are somewhat different cases, but are nonetheless likely to be impacted. Federal-Mogul is also facing likely production curtailments in its OE segments in Q2 and possibly into Q3 given parts shortages and supply chain disruptions from the tragedy in Japan, and Cooper Tire should see a combination of lower miles driven pressure replacement tire demand and higher cost of goods sold (COGS) given that petroleum derivatives represent approximately 35 percent of sales. Lower miles driven, in turn leading to lower accidents, should also place modest pressure on the collision space, to the detriment of Copart, Inc., KAR Auction Services, LKQ Corporation and Solera Holdings, Inc. Higher fuel prices also negatively impact COGS for the salvage auction operators as tow companies look to recover a portion of their higher operating costs.

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