Why Advance Auto Parts Stock Keeps Dropping

What happened

Shares of Advance Auto Parts (AAP -5.64%) retreated for a second straight day Friday after reporting earnings on Wednesday. The news this week wasn’t great. Revenues inched up less than 1%, gross-profit margins declined, and earnings per share (EPS) were cut nearly in half to just $1.43 per share. Little wonder, then, that Advanced Auto Parts announced it is switching CEOs and installing Shane O’Kelly in the office effective Sept. 11.

Wall Street doesn’t seem convinced that a change in CEO will suffice to save this car parts dealer, however. Yesterday, five separate analysts cut their price targets on the stock, and this morning a sixth — Stephens — joined in with one of the lowest targets we’ve yet seen: $71 per share.

Advanced Auto Parts stock is retreating further on the news, down 6.2% as of 1:20 p.m. ET.

So what

What is it that Wall Street doesn’t like about Advanced Auto Parts? Well, the earnings miss certainly didn’t help. But what worries Stephens even more (according to a report by TheFly.com) is that Advanced Auto Parts is continuing to make “price investments” — i.e., discounts — that are having a deleterious effect upon profit margins such that even a 1% improvement in sales results in even worse earnings.  

This echoes worries voiced by Truist bank yesterday, by the way, which announced the lowest price target on Advanced Auto Parts yet: $65.

Now what

And yet, you may have noticed that $71 — or even $65 — are actually both price targets above where Advanced Auto Parts stock trades today. For that matter, neither Stephens today nor Truist yesterday is saying that Advanced Auto Parts stock should actually be sold. Rather, both bankers are simply adopting a wait and see approach until there’s some hard evidence that Advanced Auto Parts’ new CEO can engineer a turnaround.

And that may be the right approach.

As Stephens observed this morning, Advanced Auto Parts’ current valuation of less than 12 times earnings “could be compelling.” All that’s needed is for the company to stop shrinking profits and start growing again to turn Advanced Auto Parts into a valuable stock to own. In that regard, forecasts are encouraging. Currently, Wall Street is thinking Advanced Auto Parts could bounce back from $5.04 per share in earnings this year to earn as much as $5.88 next year — 17% growth.  

Combined with a modest 1.4% dividend yield, that growth rate could make Advanced Auto Parts quite attractive at under 12 times earnings. But first things first. First…we need to see the company grow at any rate at all.

Rich Smith has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Truist Financial. The Motley Fool has a disclosure policy.

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