Thereâ€™s a cloud of diminished profits hanging over one of the U.S. marketâ€™s leading auto parts retailers. In an economy which shows signs of slowing down and where consumers are less willing to open their wallets, the company says it has to re-examine itself.
Our sales for the quarter were disappointing, said Mike Coppola, Chairman and CEO of Advanced Auto parts. The company reported last week that profit from April to June was down 4.5 percent from a similar period last year. In this challenging environment, we must improve our execution in every area of the company.
Advanced, the second largest auto parts company in the country, is a firm particularly vulnerable to fluctuations in the economy, with the majority of its customers being either low or middle income. Coppola said the company would reexamine its stores, its customer service and advertising, along with how the company spends its money.
We believe that these actions will more effectively position us for the future,â€ Coppola said.
Eighty-four percent of the auto retailerâ€™s base is do-it-yourself (DIY) consumers, according to the Zacks investment research report. Considered a cyclical sector, the auto-parts industry is seen by many as a leading indicator of the general economy due to its high sensitivity to consumer discretionary spending.
Recently, Standard & Poorâ€™s released an outlook report on Advance Auto Parts, stating that despite the softness in consumer spending, the companyâ€™s credit rating would not be downgraded. However the firm faces a daunting future as it operates in an industry that in the short term is undergoing significant changes.
Cutting Back on Discretionary Spending.Within the last two years, consumers have been dealing with higher oil prices and rising interest rates.
This month, the Federal Reserve stopped rate hikes of a key interest rate after two years of raising them for a key interest rate at 5.25 percent, noting that the economy had slowed down to the point where additional economic data would be necessary to determine if further tightening of credit was necessary.
Energy prices, most notably gasoline prices, have also spiked upward by 15 percent in the last year, according to the New York Mercantile Exchange. The national average price for gasoline has topped $3 per gallon. In addition, geopolitical factors, including instability in the Middle East and a large oil field closure in Alaska by oil company BP, have recently contributed the rising prices.
The average do-it-yourself customer has less flexibility in spending habits, according to Standard & Poorâ€™s research analyst Stella Kapur.
â€œAuto accessories are the most vulnerable category, as consumers may forego these types of purchases,â€ said she wrote in research notes.
Sales at Advance Auto Parts grew 8.3 percent to $1.11 billion. However that number was down from last in company stores that have been around for at least one year.
We believe that sales are being impacted unfavorably by macroeconomic conditions that have reduced our customers' discretionary income, and second quarter sales compared to a strong 9.0 percent comparable-store increase last year,â€ Coppola said.
Industry Competition. For the auto parts industry, weaker consumer spending means that the prospect of selling products at lower prices could affect companiesâ€™ operating margin.
Advanced Autoâ€™s operating margin in the second quarter this year dropped 2 percent to $110 million compared to a year ago.
â€œAdditionally, consumers may choose to trade down to lower-priced generic parts from premium or branded parts,â€ added Kapur.
High material costs also cut deeply into the companyâ€™s operating margin. Commodities have been rising in price, partially driven by the fast pace of Chinaâ€™s economic growth. Its national GDP is up 9.6 percent on strong construction and infrastructure requirements
â€œPricing remains under pressure, as the company competes with other automotive retailers,â€ stated a Zacks research report.
Industry Future. In the long term, the industry will mature as its growth rate begins to peak. The automotive aftermarket is expected to grow around 3.8 percent in 2006, compared with 4.6 percent, according to the Automotive Aftermarket Industry Association (AAIA).
Despite the worrying industry trends, Kapar considers Advanced Auto to be a firm that will withstand the current downturn. S&P upgraded the firm from stable to positive.
â€œAdvance Auto Parts has the most room in its current rating to digest a period of weaker demand because of its adequate credit metrics,â€ she said.