Advance Auto Parts has been treading water for the past six months, recording a small loss of 2.3% while holding steady at $51.49. The stock also fell short of the S&P 500’s 15.6% gain during that period.

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Why Do We Think Advance Auto Parts Will Underperform?

We're cautious about Advance Auto Parts. Here are three reasons there are better opportunities than AAP and a stock we'd rather own.

1. Flat Same-Store Sales Indicate Weak Demand

Same-store sales show the change in sales for a retailer's e-commerce platform and brick-and-mortar shops that have existed for at least a year. This is a key performance indicator because it measures organic growth.

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. Free Cash Flow Margin Dropping

Free cash flow isn't a prominently featured metric in company financials and earnings releases, but we think it's telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.

As you can see below, Advance Auto Parts’s margin dropped by 6.7 percentage points over the last year. Almost any movement in the wrong direction is undesirable because it is already burning cash. If the trend continues, it could signal it’s in the middle of a big investment cycle. Advance Auto Parts’s free cash flow margin for the trailing 12 months was negative 4.7%.

3. High Debt Levels Increase Risk

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’s $5.56 billion of debt exceeds the $3.17 billion of cash on its balance sheet. Furthermore, its 7× net-debt-to-EBITDA ratio (based on its EBITDA of $332.3 million over the last 12 months) shows the company is overleveraged.

At this level of debt, incremental borrowing becomes increasingly expensive and credit agencies could downgrade the company’s rating if profitability falls. Advance Auto Parts could also be backed into a corner if the market turns unexpectedly – a situation we seek to avoid as investors in high-quality companies.

We hope Advance Auto Parts can improve its balance sheet and remain cautious until it increases its profitability or pays down its debt.

Final Judgment

We see the value of companies helping consumers, but in the case of Advance Auto Parts, we’re out. With its shares underperforming the market lately, the stock trades at 19.7× forward P/E (or $51.49 per share). This valuation tells us it’s a bit of a market darling with a lot of good news priced in - we think there are better opportunities elsewhere. Let us point you toward a safe-and-steady industrials business benefiting from an upgrade cycle.

Stocks We Would Buy Instead of Advance Auto Parts

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