Thursday, November 28, 2013

Auto Parts: You Must Own One Stock in This Sector

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Plenty of sectors have at least one must-own long-term stock. With a little thought and research, they aren’t too hard to find. But in a few cases, little subsectors might contain companies that don’t get a lot of recognition despite their products being intrinsic to our everyday human experience.

Cars come to mind, and you could probably get away with owning a common car dealer like Toyota (TMC). The problem with this approach, though, is that auto manufacturers are economically sensitive and can have really bad years. That's why I go one level deeper to what I call "infrastructure" plays, which in this case means auto parts.

See, cars are always going to be on the roads all over the world. They will always be sold because all cars eventually die. And along the way, no matter how well-engineered they are, they will need parts and require maintenance. That's why you should own a stock in the auto parts sector for the long term. The challenge is in picking the right one.  Here's a quick look at your options:

AutoZone (AZO) is a $15 billion company with 5,109 stores in the US and Mexico. It holds $4 billion in debt and $133 million in cash and generates very reliable free cash flow of $800 million to $900 million annually. AZO has a projected long term-growth rate of 14.8%, and trades at a FY13 P/E of just 14. That’s a lot of debt for the company, but it’s cheap at just under 5%, and very manageable.

Genuine Parts Company (GPC) is a $12 billion company with 1,100 Napa Auto Parts stores in the US, Canada, and Mexico. It holds $250 million in debt and $197 million in cash.  Free cash flow improved to $800 million in FY12 from $600 million in FY11. GPC has a projected long term-growth rate of 10%, and trades at a FY13 P/E of 19, so I consider it vastly overvalued.

Advance Auto Parts (AAP) is a $7.4 billion company with 4,000 stores in the US, Canada, and Mexico. It’s $604 million in debt is almost entirely offset by its $520 million in cash.  Free cash flow is a bit inconsistent, swinging up and down over the years, but presently at a very solid $410 million. AAP has a projected long-term growth rate of 13.5%, and trades at a FY13 P/E of 18, so it is also overvalued.

O'Reilly Automotive (ORLY) is also a $15 billion company with 4,000 stores in the US alone. It holds $1.4 billion in debt and $366 million in cash, and generates strongly increasing levels of free cash flow — from $350 million in FY10 to $800 million in FY11, up to $950 million in FY12. It has a projected long-term growth rate of 17.3%, and trades at a FY13 P/E of 18.5. The stock is a bit pricey, but the fantastic cash flow trend, and 3% interest on debt makes it a compelling consideration.

Pep Boys (PBY) is a $690 million company with 750 stores in the US. It holds only $197 million in debt and $65 million in cash. Its free cash flow situation is less compelling, with only $34 million in FY12, coming after a breakeven FY11 — that's what you get with a smaller company trying to expand its footprint. It's a bit slower growing at 14% long-term, and trades at a current year P/E of 13, so it is arguably a tiny bit undervalued. Buying here means you are betting they will win market share in a very crowded field.

Motorcar Parts of America (MPAA) is the tiniest entry at only a $208 million market cap. It's a bit more specialized, focusing more on alternators, starters and wheel hub assemblies. It also distributes only through the DIY stores. MPAA sits on $100 million in debt and $16 million in cash. It’s cash flow negative and trades at a P/E of 14 on long term growth of 15%. I'd stay away from this one, given the cash flow situation.

In conclusion, I think you want to be with AutoZone or O'Reilly here. The latter is on a stronger cash flow trend, but both appear to be slightly undervalued, and very good stocks to own.

As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities. He is president of PDL Broker, Inc., which brokers financing, strategic investments and distressed asset purchases between private equity firms and businesses. He also has written two books and blogs about public policy, journalistic integrity, popular culture, and world affairs. Contact him at pdlcapital66@gmail.com and follow his tweets @ichabodscranium.

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