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The Bump in the Road at Advance Auto Parts

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The auto-parts industry is booming. Why isn't this company?

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Automotive parts retailers have been hitting on all cylinders during the recession as new-car sales lag and many owners buy replacement parts to get more miles out of their faithful clunker.

Overall, the aftermarket auto-parts industry grew in 2009, and the long-term outlook remains strong because national retailers grab only about 20% of the highly fragmented market.

But Advance Auto Parts (AAP), operator of about 3,400 stores in 39 states, Puerto Rico, and the Virgin Islands, has hit a bump in the road.

FBR Capital Markets on Monday downgraded the company's stock to "underperform" from "market perform" on lower earnings outlook.

Analysts Stephen Chick and Anne E. McCormick say they expect the company to earn $0.44 a share in the fourth quarter, or $0.02 below the consensus estimate. For 2010, the analysts expect the company to earn $2.97 a share. The consensus estimate is $3.27.

The stock closed Friday at $40.92 a share. FBR Capital Markets set a $36 price target. In mid-day trading Monday, Advance Auto Shares changed hands at $40.76 each, down $0.16, or 0.39%.

CEO Darren Jackson, who took over the company in January 2008, has spent heavily to boost commercial sales, but FBR Capital Markets says the initiatives probably won't meet the company's stated goal.

"We debate the payoff and linearity of management's investments," Chick and McCormick say in a research note.

Advance Auto Parts has added about 2,330 employees to handle commercial sales, a 50% increase in 2009, but commercial sales still lag behind the competition and are unlikely to achieve the goal of $20,000 a week per store. The analysts estimate commercial sales now total about half the company's goal and trail O'Reilly Automotive's (ORLY) commercial sales of about $11,900 per week per store and Genuine Parts Company's (GPC) commercial sales of $10,800 per week at each store. AutoZone (AZO), the retail leader, generates an estimated $6,300 per week in commercial sales for each store.

The analysts expect Advance Auto's same-store sales to decline 1.1% next year.

Last month, Advance Auto said sales at stores opened at least a year increased 4.7% in the company's third quarter. But David Schick, an analyst at Stifel Nicolaus, looked for a 5.6% increase in sales, especially in view of the company's efforts to increase commercial sales.

Analysts say Advance Auto Parts could easily boost sales per square foot, a basic measure of retail efficiency, but didn't show significant improvement. Worse, many analysts expect sales of replacement parts to the do-it-yourself market to slow if the economy rebounds and new-car sales recover.

Morningstar says AutoZone is the most efficient retailer, averaging sales of $239 per square foot compared with $211 for Advance Auto and $201 for O'Reilly Automotive. Retail sales provide the bulk of revenue in the sector, but the companies have moved into the commercial market and sell to repair shops and garages. Genuine Parts Company, majority owner of the National Auto Parts Association (better known as NAPA) has long supplied parts to auto-repair shops.

Size matters in the retail auto-parts business: AutoZone is the sector leader with about 4,200 stores in the US, Mexico, and Puerto Rico. O'Reilly Automotive operates about 3,415 stores in the US. Companies such as Pep Boys (PBY) -- with about 560 stores in 35 states -- likely will face increasing difficulty in competing with their larger rivals.
No positions in stocks mentioned.
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