PBY Prospect Capital Corporaton

We reiterate our Neutral recommendation on Advance Auto Parts Inc. (AAP) which operates in the U.S. automotive aftermarket industry and is primarily engaged in selling replacement parts (excluding tires), accessories, maintenance items, batteries and automotive fluids for cars and light trucks. It is the second leading retailer catering to the DIY and DIFM (or Commercial) customers.

Advance Auto released its financial results on August 10, 2011 for the second quarter of the year. The company reported a net income of $113.6 million in the second quarter of fiscal 2011, which was 12.6% higher than $100.9 million in the year-ago quarter.

However, on a per share basis, earnings improved 26% to $1.46 from $1.16 a year ago due to a decline in average shares outstanding to 77.4 million from 86.4 million in the second quarter of fiscal 2011.

Sales increased 4.4% to $1.48 billion, driven by a net addition of 130 stores during the past 12 months. Sales per store increased to $1,700 from $1,638 a year ago. Gross profit climbed 2.9% year over year to $735.8 million but gross margin reduced to 49.7% from 50.4% in the prior-year quarter.

Advance Auto’s profit has advanced through an aggressive store expansion strategy in every quarter, enabling better availability of parts for its customers. In the first half of 2011, it opened 65 stores. The company has achieved increased DIY and DIFM sales by improving availability of parts at its stores.

Advance Auto reviewed its business strategies to drive sales, lower costs and increase return on invested capital (ROIC). The company aims to improve its supply chain and vendor terms.

It has implemented an aggressive program to reduce the inventory of other less-profitable products, which in turn will free up cash to increase parts availability. The company is also directly sourcing products from low-cost countries in an effort to improve margins.

The company also pursues an aggressive share repurchase policy. In the first half of 2011, the company has repurchased 8.2 million shares at an aggregate cost of $509.7 million. On August 9, 2011, the company’s Board of Directors authorized a $300 million share repurchase program, replacing the previous $500 million share repurchase program, which had $112 million remaining.

However, a sluggish economy and volatile gasoline prices are some of the factors raising our concern about Advance Auto Parts’ performance in the near term. The slow economy and uncertainty in the market are forcing consumers to refrain from expenditures, such as purchases of replacement parts, unless absolutely necessary.

Intensifying competition from automotive retailers such as AutoZone Inc. (AZO), O’Reilly Automotive Inc. (ORLY) and Pep Boys - Manny, Moe & Jack (PBY) has also become a concern.

Advance Auto’s cash position has deteriorated. The company had cash and cash equivalents of $68.8 million as of July 16, 2011, a marked decrease from $160.8 million in the corresponding period a year ago.

The shares of Advance Auto maintain a Zacks#3 Rank that translates into a short-term “Hold” rating.

 
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