Advance Auto Bid Seen as Value Meets Record Age: Real M&A
Advance Auto Parts Inc. (AAP), the seller of car batteries and motor oil, is offering potential suitors one of the industry’s lowest valuations at a time when Americans are spending more for vehicle upkeep.
The auto-parts retailer hired Blackstone Group LP to evaluate its strategic options, a person with knowledge of the matter said this month. Even though takeover speculation has driven Advance Auto’s shares 12 percent higher since Oct. 31, they are priced at the second-lowest multiple to free cash flow among peers, according to data compiled by Bloomberg.
While Advance Auto just posted back-to-back quarterly profit declines for the first time in almost four years, the outlook for car-parts stores has brightened with the age of U.S. vehicles at a record high, boosting the need for maintenance. With the least net debt versus market value in the industry, the $5.7 billion company looks like a leveraged-buyout candidate, said ISI Group. AutoZone Inc. (AZO) and O’Reilly Automotive Inc. (ORLY), Advance Auto’s bigger competitors, may view buying it as an inexpensive way to expand, according to Argus Research Co.
“It’s an appealing target,” Paul Dietrich, the chief executive officer of Middleburg, Virginia-based Foxhall Capital Management Inc., an Advance Auto shareholder, said in a telephone interview. “As people keep their cars longer, there’s going to continue to be an increased demand for the sort of auto parts that Advance Auto sells.”
Advance Auto’s stock price declined 15 percent through yesterday from this year’s high of $92.37 in April. The slump accelerated in May when the company described recent sales trends as “challenging,” saying a mild winter led to less need for vehicle repairs. The shares have also fallen as analysts project a 0.7 percent increase in Advance Auto’s revenue this year, the slowest annual rate since at least 1998, data compiled by Bloomberg show.
With the shares languishing, a person with knowledge of the matter said on Nov. 1 that Advance Auto had hired Blackstone to consider a change in strategy. The person declined to be named because the process is private.
Shelly Whitaker, a spokeswoman for Roanoke, Virginia-based Advance Auto, said the company doesn’t comment on speculation, when asked whether it has hired Blackstone or is holding talks with any potential acquirers.
Advance Auto is evaluating a course change after its stock price slipped last month to 4.2 times the value of the company’s net assets, its lowest price-book multiple since August 2010, data compiled by Bloomberg show. The shares are relatively inexpensive in terms of free cash flow, or cash from operations after deducting capital expenses, trading at a multiple of 12. That’s cheaper than every U.S. auto-retail chain larger than $500 million, except O’Reilly Automotive at 11, the data show.
Today, Advance Auto shares climbed 1.3 percent to $79.27, ending a five-day losing streak.
The industry is benefiting as Americans keep their cars longer. Personal spending on auto parts has risen 11 percent since the U.S. recession ended in 2009, data compiled by the Bureau of Economic Analysis show. Expenditures are increasing after the average age of cars and light trucks on U.S. roads hit a record 10.8 years, according to R.L. Polk & Co.
That trend may lure interest from private-equity firms, said Bill Selesky, a New York-based analyst at Argus Research.
“The average car on the road is pretty old, so it has to be repaired,” he said in a phone interview. “These guys, you would think, would benefit from consumers trying to stretch their dollars as best as possible. Rather than plunking down 25 grand on a new car, they can just maintain what they have.”
Strong cash generation and minimal debt are the hallmarks of a leveraged-buyout target, said Greg Melich, a New York-based analyst at ISI Group. Advance Auto’s $121 million in net debt is equal to just 2.1 percent of its market capitalization, making it the least leveraged company in the industry, the data show.
“In terms of being an LBO candidate, it’s one that screens quite well,” Melich said in a phone interview. “That stable positive free cash flow can be used to pay down the debt” created by such a buyout.
There’s also room to boost Advance Auto’s profit margin, said shareholder Scharf Investments LLC. Advance Auto earned less than 11 cents in operating earnings for every dollar of sales during the last 12 months, versus 16 cents and 19 cents at O’Reilly Automotive and AutoZone, respectively, the data show.
“It has a lot of margin expansion potential,” Brian Krawez, the president of Scotts Valley, California-based Scharf Investments, which oversees $1.7 billion, said in a phone interview. “We’re a little disappointed in the short-term headwinds, but I think it’s a very attractive company and I can see why a financial buyer would be interested.”
Argus’s Selesky said Advance Auto’s approximately 3,727 stores may also appeal to the company’s larger rivals, AutoZone and O’Reilly Automotive, which have market capitalizations of $13.8 billion and $10.1 billion, respectively. As of Dec. 31, the states where Advance Auto had the most stores were Florida, North Carolina, Georgia and Ohio.
“For any of the bigger players who want to become more geographically diverse and add stores in some states that they don’t have coverage in, that’s always the easier way to do it,” the analyst said.
Mark Merz, a spokesman for Springfield, Missouri-based O’Reilly Automotive, didn’t return a phone call seeking comment. Ray Pohlman, a spokesman for Memphis, Tennessee-based AutoZone, didn’t respond to phone and e-mail messages.
Prospects for a competitor to purchase Advance Auto are limited due to overlapping locations, said ISI Group’s Melich. Krawez of Scharf Investments agreed that this reduces the odds that a so-called strategic buyer would bid for Advance Auto, leaving private-equity firms as the more likely candidates.
Krawez said Advance Auto is worth at least $95 a share, or 21 percent higher than yesterday’s close of $78.27. That would exceed the record high set earlier this year.
Because of the company’s strong prospects, “I don’t want to see the stock taken away from us at a cheap price,” he said.
A $95-a-share offer would value Advance Auto’s equity at almost $7 billion and give it an enterprise value that’s 8.4 times earnings before interest, taxes, depreciation and amortization. In the industry’s most recent deal of comparable size, the 2008 purchase of CSK Auto Corp., O’Reilly Automotive paid 9.7 times Ebitda, data compiled by Bloomberg show.
Buyers should strike now before Advance Auto’s stock price climbs and business picks up as consumers increase spending on car parts, said Foxhall Capital’s Dietrich. He said that Advance Auto’s business deceleration this year is temporary, and over the long haul, the company will benefit given that U.S. car owners are holding onto their vehicles longer.
“It’s a bad time for them to sell, but now would be a good time for someone to come in and buy them because they do have these trends in their favor,” he said. “I’m sure there are a lot of hedge funds looking to deploy cash, and this would be a solid company to pick up at a low point.”
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