Auto Parts: A Potential Value, Or A Value Trap?
Retailers of all kinds are in the dumpster this year. The hardest hit seem to be the big mall retailers like Sears, JCPenny, and Macy’s — their stock prices are down more than 48% in the last year. Yikes!
I first wrote about the alleged demise of retail back in May when I asked the question “Is Retail Dead?”
While I was fairly convinced that physical retail was going to be a lot smaller in the near future, I’m not one of those people that believes physical retail will completely die. There’s still life left in brick and mortar stores, but most investors are negative about the sector right now.
Ultimately, I think a few special retailers are going to survive because of the unique niches they inhabit. Investing in these companies is tricky, because it’s not yet obvious who’s going to survive and who’s going to… err… shit the bed?
Back in May, I singled out Home Depot as a potential survivor of the retail war. Subsequent Home Depot earnings reports have since added further evidence to my survivor theory. The Good Ship Orange is sailing along just fine, thankyou!
But where are the other physical retailers that will survive? Mall-based retailers are generally doing terrible, but what about stand-alone stores? Could investors be throwing out other “retail babies” with the bathwater?
I’ve had my eyes scanning for possible survivors the last few months, and I may have found a possibility…
It’s A Car Nation
The United States is a country powered by automobiles. Oh sure, a few large cities might have a subway, or light rail system, but largely Americans are transported by automobiles. Cars, trucks, buses, and motorcycles.
We absolutely NEED our cars to get to work, to travel long distances, and to engage in our favorite personal hobbies. Mr. Money Mustache still has A LOT of face punching to do before that changes.
It doesn’t matter if those cars are powered by internal combustion engines or three phase induction motors, cars are going to be with us for a very long time. Well into the future.
We’re also a nation in a hurry, so when something finally breaks on our beloved cars, we absolutely need parts IMMEDIATELY to keep our lives moving forward.
The idea of waiting around days for a package to be delivered doesn’t fly when you need your car to get to work tomorrow. You’ll willingly pay extra to get those parts today.
DIY auto part retailers fill this unique local niche… A niche I believe Amazon hasn’t completely conquered yet.
Yes, I’m talking about auto part retailers like O’Reilly’s (symbol: ORLY), AutoZone (symbol: AZO), Napa Auto Parts (a subsidiary of Genuine Parts Co. (symbol: GPC)), and Advance Auto Parts (symbol: AAP).
Besides supplying parts, these retailers provide knowledgeable employees to answer questions, tool loan programs, online ordering and in-store pickup, used oil and battery recycling, and other services valuable to car enthusiasts and DIY mechanics. (Not everyone takes their car to the dealership for repairs!)
Besides the parts, Amazon offers none of those services today. It has me thinking that some of the retailers in the DIY auto parts space might have a future.
Don’t get me wrong, auto parts retailers have been punished in 2017. Stock prices have tanked along with the rest of the retail space.
Typically sales growth in retail stores takes two forms: Increasing sales at existing stores (Same Store Sales growth), or growth from the opening of new stores. In the case of U.S. auto parts retailers, most growth appears to be coming from the opening of new retail stores.
The Competition
Here in lies the problem (and the reason why these stocks are tanking) — A certain segment of customers doesn’t need parts immediately. This customer can wait a couple days as long as the price is right.
This is where Amazon is making inroads — Prices. Based upon my own survey of part prices, Amazon offers significantly cheaper parts than my local retailers.
According to a NYPost report, Amazon may even be paying parts suppliers up to 30% more, despite having prices that are 10-20% cheaper than the usual parts retailers.
How can Amazon afford to do this? They’re a giant that can willingly afford to take losses for years without any consequences…effectively pushing smaller retailers out of business.
Furthermore, as Amazon expands same day delivery (now in 40 major U.S. cities), the unique value niche of local auto parts stores is being eroded.
(Check to see if your zip code is covered by Amazon’s same day delivery.)
How many U.S. cities will Amazon ultimately reach with same day shipping? Do auto parts retailers stand a chance against this unrelenting online onslaught?
There’s a lot of good questions to answer before investing your hard earned dollars.
In recent years, business has been almost too good for the likes of AutoZone and Oreilly’s — they both sporting net margins over 11%. Margins like that are almost unheard of in the retail space.
I think there’s significantly more pain ahead as these business come back down to earth.
Could the likes of Oreilly’s and Autozone survive on operating profit margins a mere tenth of what they are today? Probably, but it would be a very close call.
Who Would I Buy?
If I was forced to pick a winner today, I’d probably pick Genuine Parts Co. (GPC)…aka Napa Auto Parts. They’re the most diversified of the companies mentioned, have the lowest debt levels, and source their own Napa branded parts. Yet they still maintain prices that are pretty competitive with Amazon. (Did I also mention that 3.26% dividend yield?)
That said, on a Price-to-Earnings basis, GPC is one of the most expensive of the stocks mentioned. It’s not a fantastic value just yet.
At this point in time, I’m not jumping to buying shares… but I am watching the sector closely. There is the possibility for one or two survivors to inhabit unique value niches, much like Home Depot does.
For now, I think these retailers will continue to lose customers to Amazon. It’s possible a few companies will start closing underperforming stores, much like mall based retailers have in recent months. Ultimately this should mean lower stock prices in the future.
In other words: the battle has only just begun in the auto parts space! No point rushing out to buy shares today… but keep your eye on it. There could be good opportunities for careful investing ahead.
Now, if only I could get Amazon to change my oil for less…
Interesting assessment you have here Mr Tako. I tend to agree with you that it’s probably not a bad idea to keep your eyes open for opportunities in this auto parts market segment, but now is definitely not the time to buy.
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One thing that these stores give me that I can’t get from Amazon is know-how. Technicians will replace the headlights in my car at no additional charge, advise me about the type of windshield-wiper blades I need, install a new battery in my key remote, etc. For me, those services are priceless, because I don’t want to install a new headlight or remote battery, dig out the tools to do so, etc. And I’d pay a few more bucks to have that expertise. So I think you’re on to something, here, Mr. Tako.
Very interesting, a topic close to my heart. I see 2 categories of DIY-ers, those who work on their own cars because they cannot afford the labor prices of a mechanic and then there are the backyard mechanic hobbyists. This latter group will likely have more time, can source their parts online (and usually does) and they are working on garage queens so they want quality parts. These group also commonly goes to their local classic car mechanic and gets their parts from them. These mechanics will have the best quality rebuilt alternators, drive shafts, and carburetors. This group already has bought and returned 3 different carbs from Napa just to find out that the parts are machined at such low standards that it’s just a matter of time for leaks and other failures to occur.
The former group needs the cheapest fuel filter, the cheapest rotor, and the cheapest coolant to keep them going. These are the individuals most commonly found at Napa. For the next 1-2 decades this group will need access to cheap parts because that’s how much longer they can keep the 1970-1990’s cars going. But early 2000 cars started getting far more sophisticated for the average person to work on and maintain AND to pass state inspections or smog. Not only did they become more sophisticated but far poorer in quality. Parts can rarely be rebuilt on these cars because of over-engineering or the labor is just too much even for the low earning individual.
I don’t think gas prices can be kept as artificially low as they have been, any longer. I don’t mean to be speculating but from my research gasoline prices will be going up and so commuting in a 1980’s car with 16 mpg’s might become prohibitive in other ways.
I definitely agree with your assessment that retail auto parts stores will be around for a while longer. However, I believe there are a few other factors to take into account:
1. gas prices won’t stay this low
2. a few more rounds of cash-for-clunkers would wipe out all remaining home-serviceable cars
3. how much longer can the world and the global economy afford making mass quantities of low quality parts
4. with retail in danger, will the lines between wholesale and retail get erased? blurred?
This is such a great analysis of what stocks will survive the online retail boom in the future. I was so sad when I heard that Macy’s is closing hundreds of stores. We live near one and like taking a walk at the store.
But it’s also true that we have turned to Amazon for the bulk of our non-food purchases. I love Amazon Prime and their customer service!
Great timing Mr Tako. Amazon is definitely shaking up the industry and could be serving up a deal to investors. Could there be consolidation in the future?
I posted a couple weeks ago that I initiated a very small position (less than 1%) in Autozone last month after years of following the company. While they aren’t a dividend payer, management returns capital via share buyback. Very much a buy and monitor situation. I follow the story closer if I have a little skin in the game.
I believe there is a customer service niche that these companies will continue to play as you described. I wonder what percent of the population is hands on with all aspects of their cars? I would pay up for advice or to have someone install a part correctly.
Up for a friendly game? I take Autozone, you take GPC. Let’s check back in a year.
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I like your idea of approach to looking for retail survivors. Home Depot is indeed a great example.
Call me crazy, but I think a total wildcard in retail auto parts is the long-term impact of autonomous cars. If the rate of adoption of autonomous vehicles happens fast enough and this leads to fewer car owners and more Uber-like services, then the general consumer won’t have much of an appetite for auto parts.
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IIIIIIInteresting. I never thought about auto parts from an investing standpoint, but this makes sense. It’s equally interesting to see how Amazon is really changing how we think about competition.
I don’t know if Amazon’s onslaught is ever going to stop in the near future. We really need a competitor to keep them in check because they’re such a unique conglomerate and uniquely positioned to dominate everyone. They don’t only provide the convenience of shopping, they have tens of thousands of stakeholders whose successes are tied to Amazon’s success. How many businesses depend on Amazon including FBA. They’re hiring tens of thousands of new employees. It seems like one out of ten people I know are working for Amazon now.
They’re certainly becoming a very important part of the economy these days. It’s pretty amazing when you think about it — it all started as an online bookstore.
Fascinating assessment Mr. Tako. I think you’re onto something here! I agree the Amazon will knock out a chunk of the competition, although I think there will always be a strong market for a retailer that can provide a little more hands on service. I think of somewhere like Autozone that will help you install the wiper blades you just purchased in store, or give you that personalized service that’s hard to recreate online. To a lot of people, cars are too complex and they just want someone to take care of it. It’ll certainly be interesting to watch this play out in the auto sector!
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Individual stock investments. Gosh I don’t know how I found the time to do all the research now.
Surprised you aren’t in index funds instead?
I own all kinds of investments: Index fund, REITs, individual stocks, bonds, preferred shares, and so forth. Why stick to only one? Broaden your horizons and you could find yourself learning something.
I agree with you that out of the bunch, GPC seems like the best deal. If there is more fear in the sector and the yield gets north of 4% by a clip, then I think it’s a good value play. The track record of GPC is pretty impressive.
Sectors that are in decline with heavy negative sentiment (and therefore weak valuations) and strong cash flows make for good investments like the tobacco companies in the 90’s and early 2000’s.
-Mike
Couldn’t agree more Mike!
I’ve been buying ORLY on he dips, I think the market has overreacted and the true impact from Amazon (if it materializes) is years away.
I think we will see a shift it auto part stores to be more of a hybrid model where they sell parts and also to repairs/ routine maintenance etc…
This will offset the impact from Amazon.
If I had to pick a retail business that had a shot at weathering the Amazon storm, this might be it. There’s definitely a service aspect to it with free advice and assistance, and the dynamics of the purchase purpose (you’re fixing a multi-thousand dollar car that probably needs immediate help, rather than buying some discretionary treat) may make even same-day delivery too slow.
It’d be interesting to combine one of these stocks with a natural hedge if you can find it (maybe TSLA?) – even if their fate is dark, they do seem too beat down right now. Nice analysis.
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I’ve often found Amazon and Walmart prices to be fairly the same on many items. I am a little bias towards Walmart perhaps because it’s so much easier to return things at the store when I need to. I recently bought my own oil and filter from there and only paid for the labor part of the oil change (saved about $30) 🙂
Auto parts stores may not be good for a long term position. Though we are many, many years away from an electric car takeover, it is coming (or some other fuel to power engines).
It is a fact that these electric engines do not require the same maintenance as fossil fueled vehicles. These filters, spark plugs and the like may become a smaller market.
Also DIY maintenance on electric cars will be less due to their complexity.
Amazon seems to be taking over the world…but I agree with you that there’s still room for brick and mortar businesses. I just don’t know which ones. Could be cars, could be hardware stores, could be clothing stores…no one knows for sure. I remember at one point, we thought netbooks were going to be the next big thing but Apple killed it with the ipad, so who knows. Only time will tell…
How are these stocks cheap? Free cashflow to price is about 17 for each. It seems a little bit high.
At this point, they’re not cheap (yet). It’s also worth pointing out that at no point in the post did I call these stocks cheap.
That wasn’t my point.
You and a coupe of the commenters have hit the nail on the head – As long as there are people at these niche retailers with expertise that they’re willing to share, there will always be customers willing to bear the brunt of higher prices. Home Depot was a great example to use – everyone lives somewhere, and most people live in a place that needs work done from time to time. The Amazon for parts/YouTube for instruction combo that more and more people seem to be following has two huge downsides – 3rd party sellers on Amazon selling crappy chinesium parts, and the fact that you can’t ask a YouTube video a question when something goes wrong. I’ll be taking your advice on buying GPC, that’s for sure!