3 Reasons to Avoid AAP and 1 Stock to Buy Instead

Over the past six months, Advance Auto Parts has been a great trade, beating the S&P 500 by 14.1%. Its stock price has climbed to $57.50, representing a healthy 17.6% increase. This was partly thanks to its solid quarterly results, and the run-up might have investors contemplating their next move.

Is there a buying opportunity in Advance Auto Parts, or does it present a risk to your portfolio? Get the full stock story straight from our expert analysts, it’s free.

Why Do We Think Advance Auto Parts Will Underperform?

Despite the momentum, we're sitting this one out for now. Here are three reasons why AAP doesn't excite us and a stock we'd rather own.

1. Flat Same-Store Sales Indicate Weak Demand

Same-store sales is a key performance indicator used to measure organic growth at brick-and-mortar shops for at least a year.

Advance Auto Parts’s demand within its existing locations has barely increased over the last two years as its same-store sales were flat.

2. Shrinking Operating Margin

Operating margin is an important measure of profitability as it shows the portion of revenue left after accounting for all core expenses – everything from the cost of goods sold to advertising and wages. It’s also useful for comparing profitability across companies with different levels of debt and tax rates because it excludes interest and taxes.

Analyzing the trend in its profitability, Advance Auto Parts’s operating margin decreased by 10.4 percentage points over the last year. Advance Auto Parts’s performance was poor no matter how you look at it - it shows that costs were rising and it couldn’t pass them onto its customers. Its operating margin for the trailing 12 months was negative 10.1%.

3. Short Cash Runway Exposes Shareholders to Potential Dilution

As long-term investors, the risk we care about most is the permanent loss of capital, which can happen when a company goes bankrupt or raises money from a disadvantaged position. This is separate from short-term stock price volatility, something we are much less bothered by.

Advance Auto Parts burned through $245.2 million of cash over the last year, and its $3.67 billion of debt exceeds the $1.67 billion of cash on its balance sheet. This is a deal breaker for us because indebted loss-making companies spell trouble.

Unless the Advance Auto Parts’s fundamentals change quickly, it might find itself in a position where it must raise capital from investors to continue operating. Whether that would be favorable is unclear because dilution is a headwind for shareholder returns.

We remain cautious of Advance Auto Parts until it generates consistent free cash flow or any of its announced financing plans materialize on its balance sheet.

Final Judgment

We cheer for all companies serving everyday consumers, but in the case of Advance Auto Parts, we’ll be cheering from the sidelines. With its shares topping the market in recent months, the stock trades at 26.7× forward P/E (or $57.50 per share). This valuation tells us it’s a bit of a market darling with a lot of good news priced in - you can find more timely opportunities elsewhere. We’d recommend looking at our favorite semiconductor picks and shovels play.

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