Advance Auto Parts has gotten torched over the last six months - since June 2024, its stock price has dropped 30.7% to $44.30 per share. This was partly due to its softer quarterly results and might have investors contemplating their next move.

Even though the stock has become cheaper, we're sitting this one out for now. Here are three reasons why you should be careful with AAP and a stock we'd rather own.

Why Do We Think Advance Auto Parts Will Underperform?

Founded in Virginia in 1932, Advance Auto Parts (NYSE:AAP) is an auto parts and accessories retailer that sells everything from carburetors to motor oil to car floor mats.

1. Flat Same-Store Sales Indicate Weak Demand

Same-store sales is a key performance indicator used to measure organic growth at brick-and-mortar shops for at least a year.

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. EPS Trending Down

Analyzing the long-term change in earnings per share (EPS) shows whether a company's incremental sales were profitable – for example, revenue could be inflated through excessive spending on advertising and promotions.

Sadly for Advance Auto Parts, its EPS declined by more than its revenue over the last five years, dropping 55.5% annually. This tells us the company struggled because its fixed cost base made it difficult to adjust to shrinking demand.

3. High Debt Levels Increase Risk

Debt is a tool that can boost company returns but presents risks if used irresponsibly. As long-term investors, we aim to avoid companies taking excessive advantage of this instrument because it could lead to insolvency.

Advance Auto Parts’s $3.81 billion of debt exceeds the $464.5 million of cash on its balance sheet. Furthermore, its 8× net-debt-to-EBITDA ratio (based on its EBITDA of $420.3 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

Advance Auto Parts falls short of our quality standards. After the recent drawdown, the stock trades at 29.6× forward EV-to-EBITDA (or $44.30 per share). At this valuation, there’s a lot of good news priced in - we think there are better opportunities elsewhere. Let us point you toward MercadoLibre, the Amazon and PayPal of Latin America.

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