Advance Sets Sights on Fiscal 2023 Margin Expansion, Filling Retiring CEO Vacancy

We don’t plan any material change to our $201 per share fair value estimate for narrow-moat Advance Auto Parts AAP after digesting fourth-quarter results. Even after a mid-single-digit lift, we view shares as attractive, trading at over a 25% discount, and think the shift to GAAP reporting signals the intention of management to focus on extracting efficiencies and improving product availability from the existing business, rather than the pursuit of significant acquisitions ahead. As such, the initial forecast for 7.8%-8.2% GAAP operating margin implies the expected capture of roughly 160 basis points in operating margin expansion in fiscal 2023, as Advance, like its peers, tends to benefit from a less elastic demand profile that isn’t as affected by inflationary pressures.

Fourth-quarter sales displayed consumer resilience, with sales that rose 3.2% to $2.5 billion, largely in line with our implied sales outlook, supported by 2.1% same-store sales. The period’s GAAP operating margin increased 64 basis points to 5.3%, helped by mix and pricing, as well as lower operating expenses (compensation and marketing), but was tamed by product cost inflation. With integration costs moderating, operating costs should remain controlled, allowing for the continued expansion of profitability over the next decade.

Moreover, as Advance is no longer a business in transition, it is now positioned to focus on greater product availability and inventory management (a critical driver of top-line growth). The stable position of the business has offered the opportunity for current CEO Tom Greco to transition into retirement at the end of 2023. While no replacement has been named, the board has begun its search. With plenty of time to ensure the appropriate transition takes place, we don’t plan any change to our Exemplary Capital Allocation Rating, and we expect no fundamental changes to the business strategy in the near term given Advance is in the final year of its three-year business plan.