Friday, August 10, 2012

A Buying Opportunity in the Auto Parts Retailers?

As everybody knows, it takes two to make a market and right now we are locked in an almost titanic battle between bears and bulls, The defensives and dividend plays are holding up whilst cyclical sectors like technology are hated. Conversely, the market crushed a stock, which I consider to be a counter-cyclical. Go figure!

Advance Auto Parts $AAP gave notice of weaker sales in April and, the market drove it down hard. The company blamed the temporary factor of weather for the slowdown and, if this is case, why is the market not giving it the benefit of the doubt if it is favoring defensives?
The answer to that question is the market’s problem. As investors we need to stay focused on the underlying fundamentals. With regards the auto parts dealers, they have had a great run over the last few years. Advance competes with O’Reilly Automotive $ORLY Autozone $AZO and Genuine Parts Co $GPC also has an auto parts division.

Advance Goes Backwards

The company blamed the mild winter weather for the sales slowdown in April. In other words, the clement temperatures encouraged car drivers to bring forward repair work, that they might have ordinarily done later in the year. Similarly, O’Reilly Automotive had previously suggested that April was running weak.
“we remain somewhat cautious regarding the sales environment and are setting our comparable store sales guidance at the 3% to 5% range. The beginning of the second quarter has gotten off to a somewhat slower start as we suspect a good amount of spring cleanup business was pulled forward from April into the first quarter as a result of the earlier-than-normal mild temperatures.”
Advance Auto said pretty much the same thing in its update.
“Although we had a very solid quarter in sales, our growth underperformed our expectations as our business significantly slowed in April, partially offsetting our fast start to our year. As we start our second quarter, we continue to see the softness that we witnessed in April. However, we believe this slowdown is temporary”
Both managements argued that relatively high gas prices had curtailed miles driven and therefore car servicing needs. However, weather is the ultimate ‘temporary’ factor. If anything, this should be a buying opportunity for those that think the economy is headed for a slowdown and, are busy piling up on defensives.

Now do you see what I mean about this market?

Why These Stocks are Counter Cyclical

Simply put, the recession caused a continued increase in the average age of the US car, as consumers held off purchasing new cars. The data, from POLK, is here.

This has benefitted the auto parts dealers because older cars require more servicing. As a general rule, the increase in servicing starts to accelerate after about 9.5 years. Therefore, this chart is like manna from heaven to the likes of Advance Auto.

So, if you are bearish on the economy, you might tend to see this number trending upwards, even from here. Furthermore, with a slowdown in China apparent, gasoline prices might start to fall. In other words, a perfect recessionary storm will be created, within which, Advance Auto could flourish. For the bears, the stock price fall caused (theoretically) by a temporary weather issue, should be a buying opportunity.

I’m not so sure.

US New Car Sales Data

The fact is, US new car sales data has been quite impressive this year and, has been trending higher for a while now and, I suspect this could be a cause of a bit of the weakness with O’Reilly, Autozone and Advance.

Furthermore, Ford $F has been making bullish noises about US car sales this year. It plans to make 40,000 more vehicles by reducing the summer shutdown at some North American plants. This is a good sign that the automobile manufacturers are feeling positive about sales. Over the year, Ford plans to increase production capacity by 400,000. It is a far cry from 2008! Similarly, the credit card companies have been reporting positive numbers for car loans.

What Next for Auto Parts Retailers?

These stocks have been wonderful performers over the last year and the diversification they give has a place in any balanced portfolio. If we are headed for a global slowdown then they will surely go higher. Therefore, this kind of weather related weakness could be creating an ideal buying opportunity.

However, I’m a great believer that economies don’t suddenly stop trending and fall of a cliff as in the Road Runner cartoons. New car sales are trending higher, consumer credit is increasing and non-farm payroll gains are on an upward trend. In other words, despite the worries over Greece, the US economy is getting in better shape. The current market weakness does not have anything to do with any of the fundamentals behind the US.  It is about fears of a disorderly default by Greece.

If the latter fear does come to pass and it stifles global growth, then these stocks will be raging buys again; but for now, the underlying fundamentals are suggesting that economic trends in the US are moving away from them.

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