Morgan Stanley: 'We've Been Wrong' On DIY Auto, Downgrades O'Reilly, AutoZone

Morgan Stanley made quite the confession by admitting it was wrong on DIY auto retail in 2017. Consequently, the firm downgraded two stocks in its coverage universe: O'Reilly Automotive Inc ORLY and AutoZone, Inc. AZO.

Weak Industry Revenue Trends

Analyst Simeon Gutman indicated that the industry's top-line growth was weaker than expected in the first half. The analyst now estimates flattish same store sales growth for 2017 compared to his initial forecast for 2.2-percent growth.

The analyst clarified that the slowdown does not reflect competitive threat by the online channel.

Among the factors Morgan Stanley views as impacting the segment were unfavorable weather, fewer 5–12-year-old vehicles and choppy consumer demand. The firm attributed its downgrade of O'Reilly and AutoZone to slower industry growth persisting in the second half of 2017.

Given the downgrade of its gross margin assumptions over the next two years, the firm expects about 2-percent downside to its previous EPS/EBIT estimates. The firm termed the 1.7-percent second-quarter comp reported by O'Reilly as not a terrible performance, relative to its coverage universe.

The firm also noted that O'Reilly's pre-announcement was sketchy, not giving enough details on the magnitude of the second quarter earnings miss, gross margin performance and monthly comp cadence.

"Applying a similar Q1 comp spread between ORLY and AZO/AAP to Q2 would imply the latter companies are comping negatively this quarter," the firm said.

"We do not believe this is the case and forecast flattish SSS for AAP and AZO."

Staying Positive On Advance Auto Parts

Meanwhile, the firm sees the positive bull/bear skew as more compelling for Advance Auto Parts, Inc. AAP, given the strategic asset value and margin upside potential.

The firm noted that the company stands to gain from Worldpac, an industry leading distributor of foreign/luxury parts, a segment, which it thinks will represent a bulk of the car population over the next five to 10 years.

Lowering Estimates Across The Board

Citing the second-quarter earnings per share and sales miss pre-announced by O'Reilly, Morgan Stanley lowered its estimates and price target for the company. The firm also lowered its estimates for the entire DIY auto space by about 25 percent, a function of lower assumed valuation multiples given weaker top-line trends and lower EPS growth trajectory.

Rating/Price Target

• Advance Auto Parts: Maintains at Overweight/price target slashed from $160 to $125.
• AutoZone: Downgraded from Overweight to Equal Weight/price target lowered from $680 to $540.
• O'Reilly: Downgraded from Overweight to Equal Weight/price target lowered from $290 to $200.