Auto parts retail enters 2023 at a continued high pace as the drivers of demand--miles driven, the increasing average age of vehicles on the road, high used car prices, and plentiful jobs--all remain “emboldened” for the year. However, Advance Auto Parts continues to be squeezed between the "executors": O’Reilly Auto Parts and AutoZone. The executors are gunning for the Pro business with increased service levels, service management tools for customers, and lower prices; these factors have allowed them to capture meaningful market share. In the context of an industry that is experiencing double-digit product inflation, Advance’s 1-year and 3-year comp CAGRs demonstrate significant market share losses. In contrast, O’Reilly’s and AutoZone’s 3-year figures are just stunning. As such, it is not surprising that Advance’s CEO Tom Greco announced his retirement by year end. In connection with Greco’s retirement, Advance’s Board formed a succession committee of its independent directors. We strongly suspect that they will reach outside of the company, as they did when hiring Greco.
O'Reilly Auto Parts
- It wasn’t just Advance changing drivers, as O’Reilly also recently announced that internal candidates Brad Beckham and Brent Kirby would be promoted to Co-Presidents under CEO Greg Johnson as a part of its long-term succession plan. (Recall that Jeff Shaw, the company's prior President and COO, retired in early 2022.)
- Q4 2022 ended on a high note for industry comps, led by O’Reilly. On O'Reilly's Q4 2022 update, Johnson stated, “I will just say that we're excited about the aggressive plans we have to invest in our business and continue to take market share and drive industry-leading results.” Beckham continued, “We saw broad-based strength across all of our markets and weather-related categories, such as batteries cooling and antifreeze, as well as our other core non-weather-related categories. We saw strength in both our DIY and professional businesses, with professional again leading the way with double-digit comparable store sales growth on robust increases in both ticket counts and average ticket size.” (Gross margin was down 130 basis points for the year which reflects both the price investment and the shift in the business to Pro. For similar reasons, AutoZone’s gross margin was down 100 bps.)
- Beckham continued: “the scarcity of vehicles has forced many consumers to keep their vehicles longer. These investments the consumers have made to keep their vehicles well maintained and paid off, and we expect to see a continued willingness by consumers to invest in their high-quality vehicles at higher and higher mileages. We also have a positive outlook on the strength of the consumer our industry and their ongoing willingness to prioritize their transportation needs. We continue to view the health of our customers as strong, supported by extremely low unemployment and robust growth in wages over the past 2 years. We think these factors provide a solid backdrop for growth in miles driven in our industry and solid demand over the next year. While miles driven still remain below pre-pandemic levels, we've seen growth in this key fundamental for our industry over the past 18 months. We believe we will see a continuation of the long-term industry trend of steady growth in miles driven, resulting from population growth and an increase in the size of the U.S. car PARC… , we anticipate average ticket on both sides of our business to benefit from low single-digit inflation arising from the carryover benefit on a YoY basis as we compare against price levels that ramped throughout 2022."
- Our interpretation of O’Reilly’s 4Q 2022 update is that the company intends to invest $60M+ to enhance service levels for the Pro business in 2023 and roll any of its savings in supply chain costs (including lower shipping container costs and lower fuel costs) into additional price concessions to drive market share in Pro, which could put additional pressure on Advance and the smaller players in the business. (The Pro segment is far more fragmented that the DIY segment.)
- O’Reilly’s sales mix is 57% DIY/43% Pro despite Pro being the larger segment of the industry. Thus, Pro is O’Reilly’s largest opportunity; moreover, it’s “an easier race to win” than competing against AutoZone in DIY.
- O’Reilly intends to open up to 190 new locations in 2023 (up from 173 in 2022). AutoZone is likely to add 135 domestic locations in 2023. Advance intends to add 70 new locations, down from the 137 added in 2022.
- AutoZone produced double-digit comparable sales growth for its Pro business (including mid-single-digit growth in transactions) and +3% comps for its domestic DIY business. On a trailing-twelve-month basis, AutoZone's Pro business is up +19% YoY to $4.5B. (AutoZone’s sales mix is 70% DIY/30% Pro.)
- AutoZone CFO Jamere Jackson shared, “Our execution on our commercial acceleration initiatives continues to deliver exceptionally strong results as we grow share by winning new business and increasing our share of wallet with existing customers. We have a commercial program in approximately 88% of our domestic stores, which leverages our DIY infrastructure. And we're building our business with national, regional and local accounts.”
- AutoZone now has 81 Mega-Hub locations (+1 quarter-over-quarter) with 25 new locations planned for 2023; the company's medium-term ambition remains 300 Mega-Hub locations. Mega-Hubs carry approx 90,000 SKUs and they drive a tremendous sales lift inside the store box as well as serving as an expanded assortment source for other nearby stores and which lifts the entire network.
- AutoZone’s CEO William Rhodes stated, “There's no question that the cost of doing business are structurally higher.” Both AutoZone and O’Reilly expect “elevated wage growth” and that is something that Advance will also have to contend with, but without the benefit of faster top-line growth.
- Other major retailers planning additional wage increases during 2023 include Dollar Tree Inc, Home Depot, Kroger, Target, and Walmart, and as these large employers “set the market” that will result in a structurally higher cost of doing business going forward industry-wide. Moreover, the increases will make the Fed’s job on inflation more difficult and the path for interest rates likely higher, which impacts the economic outlook.
Advance Auto Parts
- As was expected, Advance Auto Parts reported a soft revenue for Q4 2022. Unlike its peers, however, it also reported flattish gross margin and lower SG&A (as a percentage of sales). Gross margin has been supported by pushing the sales mix into private-branded product and away from national brands; an initiative that has been ongoing. What has now become obvious to all is that Advance has gotten to the point where it can not both maintain market share and margin. Outgoing CEO Greco chose margin, Advance’s next CEO may take a different approach.
- Advance business mix (at the stores) is 45% DIY/55% Pro. The Pro segment comped negative during Q4 2022 and has been soft all of 2022. As mentioned and as part of their “margin maximization” strategy, Advance’s overall product mix shifted towards private-branded product. For Q4 2022, this shift was 210 bps to 50.5%, implying that the sales of national branded product were down around -4% in dollars and mid-teens in volume. This is a dynamic that will be noticed by their branded suppliers.
- Looking at the DIY segment in Florida, where all three have a sizable presence, we see that Advance (488 locations) underperformed AutoZone (379) and O’Reilly (241) each of the past four months.