Gee whiz. Talk about an "ouch." On Wednesday morning, Advance Auto Parts (AAP) released the firm's fiscal first quarter financial results. Those results were not pretty and were not even close to pretty. Let's move on.
For the 16 week period ended April 22nd, Advance Auto Parts posted GAAP EPS of $0.72 on revenue of $3.417B. The EPS print is well below the $2.57 or so that Wall Street was looking for, and down from the $2.26 comp from the year ago period. Those bottom line results may not be all that comparable. The bottom line result fell just a touch short of estimates, while reflecting year over year growth of 1.5%. Comp store sales showed a year over year contraction of 0.4%.
While net sales were growing 1.5%, the cost of those sales increased 4.2% to $1.947B. This resulted in gross profit of $1.471B (-2.3%) and a gross margin of 43%, which was down from 44.7% for the year ago period. Operating expenses increased 6% to $1.381B, dropping operating income to $90M (-55.7%) from $203.3M. After accounting for interest and taxes, net income fell 69.5% to $42.7M.
The CEO
In the press release, on the quarter reported, president and CEO Tom Greco commented: "While we anticipated the first quarter would be challenging, our results were below our expectations. Net sales grew 1.3% in the quarter. Our operating margin rate of 2.6% in the quarter was well below expectations due to higher than planned investments to narrow competitive price gaps in the professional sales channel as well as an unfavorable product mix."
Greco went on: "We expect the competitive dynamics we faced in the first quarter to continue, resulting in a shortfall to our 2023 expectations. We have reduced our full-year guidance and our board of directors made the difficult decision to reduce our quarterly dividend. In addition, in connection with my pending retirement, our board's independent chair, Gene Lee has assumed an expanded role as interim executive chair."
Whoa. How does one retire after a quarter like that? I don't know, unless the board has simply removed the welcome mat from in front of one's door.
Guidance
CFO Jeff Sheperd added to Tom Greco's commentary: "Given the shortfall experienced this quarter, along with our revised outlook for the balance of the year, we are reducing our full year 2023 guidance. In addition, our board of directors made the decision to reduce our quarterly cash dividend to provide enhanced financial flexibility."
Now, for the changes to full year guidance. I suggest that the AAP shareholders among my readers sit down prior to proceeding.
For the full year, Advance Auto Parts now sees net sales of $11.2B to $11.3B, down from $11.4B to $11.6B. The firm sees comp store sales at "growth" of -1% to flat, down from +1% to +3%. Operating income margin is now seen at 5% to 5.3%, down from previously given guidance of 7.8% to 8.2%.
Yes, there's more. Full year GAAP EPS is now expected to land in a range spanning from $6 to $6.50 down from guidance three months ago of $10.20 to $11.20. Free cash flow generation is now expected to post at $200M to $300M. The firm had previously stated its expectations for full year free cash flow of $400M+. Uglee. Make that Fruglee (that's short for "freakin' ugly).
Fundamentals
For the quarter reported, Advance Auto Parts generated an operating cash flow of $-378.9M. The firm also made $90M in purchases of property and equipment, bringing free cash flow to $-468.9M. Making matters worse, the firm returned $89.5M to shareholders in the form of cash dividends and another $12.6M in the repurchase of common stock.
Returns to shareholders are, in a perfect world, supposed to come out of free cash flow. Hence, the reason why the firm announced a quarterly dividend of $0.25 per share. which is down from $1.50 prior, which the firm had paid out for five consecutive quarters. This drops AAP's dividend yield from 5.35% to 0.89% based on Tuesday's last sale of $112.20. The stock was recently trading close to $77 per share, down about 31%.
Turning to the balance sheet, AAP ended the period with a cash position of $226.5M and inventories of $5.016B. Those numbers were down and up sequentially respective to the fiscal fourth quarter. This puts current assets at $6.202B. Current liabilities add up to $4.983B, including $116M in shorter-term debt. This puts the firm's current ratio at what looks like a healthy 1.24. That is healthy as long as that massive inventory valuation can be sold close to that stated value. The firm's quick ratio runs at a startlingly poor 0.24.
Total assets stand at $12.182B including $1.603B in goodwill and other intangibles. At 13.2% of total assets, I don't see this as a problem. Total liabilities less equity comes to $9.546B including $1.785B in long-term debt. The high inventory levels, and the daunting debt to cash ratio does not allow this balance sheet to pass the Sarge test. This balance sheet needs a lot of work before we can give it a passing grade. It all starts with turning around that negative free cash flow. Management seems to understand. At least there will be a change at the top.
My Thoughts
It would be difficult to put capital to work behind a name about to undergo a transition in leadership. It is also difficult to see how a change can not help. Greco took over in April of 2016 with the shares trading in the $150's to $160's. I now see them trading with a $77 handle. Not exactly a triumphant tenure. I don't think an investor can go out on a limb based on execution and certainly not based on guidance. The fundamentals need a lot of work as well.
The next CEO may have to cut the dividend again, and I think it's safe to say that the firm should not be repurchasing any common stock for its corporate treasury any time soon. Fortunately, most of the debt is not current, so it probably was borrowed at lower rates than would be available if those maturities had to be pushed out this year.
That said, the massive inventories which are considerably higher than was the firm's norm just a few years ago, might be a lingering problem. This stock closed trading at 10 times forward looking earnings. That will change today (Wednesday). The PE ratio may be low relative to the S&P 500, but this stock even now, is in no way inexpensive.
I would need to see the shares stabilize to even think about placing a speculative equity stake. That said, there will be some volatility in the coming days. A directional call spread could make some short-term dough, but understand that this would be a play on short sellers taking profits and other traders trying to game that action. I do not see this as an investment opportunity at this time.
