Shifting Gears On Auto Parts Stores: AutoZone, Advance Auto And O'Reilly's Downgraded

The aftermarket auto parts sector isn't a "wreck," according to Bank of America's Denise Chai.

Although many stocks are trading near their respective multi-year lows, the sector is suffering from various industry wide trends and entering a period of lower sustained growth after a few years of strong performance. As such, the following rating changes were made:

• Advance Auto Parts AAP from Neutral to Underperform with a price target lowered from $150 to $90.
• AutoZone, Inc. AZO from Buy to Neutral with a price target lowered from $750 to $575.
• O'Reilly Automotive Inc ORLY from Buy to Neutral with a price target lowered from $325 to $200.

So Now What?

Auto parts retailers rely on business coming from consumers who continue operating older cars, the analyst noted. But a trend started to emerge in 2015 whereby consumers started favoring smaller/mid/cross-over vehicles, which cost less to maintain versus larger vehicles. On top of that, consumers continue to embrace electric and hybrid vehicles which similarly require less money to maintain versus combustion vehicles.

These factors imply the sector will operate a period of lower sustained growth, which implies investors should be more selective in their stock picking.

No Boost From Low Income Consumers

Another bullish factor working in favor of the group is lower income consumers investing in their older cars rather than buying new vehicles. But there are many factors at play that will limit low income consumer spending over the coming years, including rising healthcare costs (especially if there are any negative changes to the Affordable Care Act), rising housing costs, declining food stamp benefits.

AutoZone, O'Reilly At Neutral

AutoZone and O'Reilly's respective Neutral ratings is based on the analyst's belief of lower growth and sustained weakness in sentiments. As such, the stocks no longer deserve to trade at a premium valuation, especially when considering that both companies will likely see ongoing elevated SG&A growth relative to comps due to new store and distribution network build outs.

Advance Auto Parts At Underperform

Chai's bearish stance on Advance Auto Parts contrasts those of Jefferies and is based on the assumption that the company is in the weakest position among all auto parts names. The company is also the most inconsistent performer in the group, which at the very least pushes out any inflection in earnings from management's turnaround efforts.

Related Links:

O'Reilly Price Target Slashed 25% Amid Warning; Weather Just One Factor Pressuring Sales

Auto Parts Stocks Are Getting Crushed Thanks To O'Reilly's Guidance Cut

Image Credit: By Michael Rivera - Own work, CC BY-SA 3.0, via Wikimedia Commons