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2 Auto Retail Parts Stocks to Hold Onto Despite Industry Weakness

The Zacks Automotive- Retail and Wholesale- Parts industry is in a fix amid concerns of economic slowdown stemming from the Fed’s aggressive monetary policy tightening to rein in inflation. Demand for cars is beginning to wane, hurting the industry’s prospects. Additionally, commodity cost inflation, supply chain snafus and escalating operational expenses may dent the industry participants’ earnings. While the shift to green vehicles may create new opportunities, operational headwinds must be addressed to stay ahead of the game. Cost management holds the key now. Industry participants like O’Reilly Automotive ORLY and AutoZone AZO seems well-poised to navigate the challenges.

Industry Overview

The Zacks Automotive – Retail and Wholesale – Parts industry players execute several functions. These include manufacturing, retailing, distribution and installation of vehicle parts, equipment and accessories. Vehicle parts and accessories include seat covers, antifreeze, engine additives, wiper blades, batteries, brake system components, belts, chassis parts, driveline parts, engine parts and fuel pumps. Consumers have two options. They can either opt for repairing vehicles on their own (the ‘do-it-yourself’ or ‘DIY’ segment) or take the assistance of a professional repair facility (the ‘do-it-for me’ or ‘DIFM’ segment) . The industry is highly competitive and undergoing a radical change, with evolving customer expectations and technological innovation acting as game changers.

Factors Shaping Industry’s Fate

Weak Economic Outlook Raises Concern:Macro headwinds such as soaring interest rates, high inflation and looming economic uncertainty have muted the industry’s prospects. To tame inflation, the Fed became ultra-aggressive, cranking up borrowing rates repeatedly in 2022. It has signaled more rate hikes in 2023 and no cuts until 2024. With borrowing getting expensive and threats of a recession looming large, consumers are gradually starting to get apprehensive about buying cars. Demand for cars has gradually started to cool off. This, in turn, is putting pressure on the near-term prospects of the auto retail and wholesale parts industry.

Supply Chain Disruption Lingers: Supply chain disruptions — a byproduct of the COVID-19 pandemic that only got aggravated by the Russia-Ukraine war — are leading to hiccups for the industry. While the logistical challenges are beginning to ease a bit, they are far from over. Further, the ongoing COVID disruption in China is only likely to make matters worse. Supply chain snare, is thus, expected to continue in the near term, limiting revenues for auto retail parts companies.

Commodity Cost Woes to Persist: The industry players are also likely to suffer from escalating prices of raw materials. Soaring costs of commodities like resin, steel, copper and aluminum have increased the manufacturing costs of the companies. The rising cost of raw materials is set to adversely impact the margins of the auto retail parts companies.

Electrification Presents Challenges & Opportunities: The introduction of more complex and high-tech vehicles has led consumers to take more professional help, thereby opening up new opportunities for the industry participants. At the same time, capex requirements and R&D costs are on the rise owing to the development of superior technological platforms and sophisticated tools. The auto retail parts industry needs to chalk out a detailed roadmap to make the most of the opportunities amid the changing market scenario. Omnichannel marketing and digitization ramp-up are also escalating operational costs, which may further limit profits.

Zacks Industry Rank Depicts Gloomy Scenario

The Zacks Auto Retail & Wholesale Parts industry is a four-stock group within the broader Zacks Auto-Tires-Trucks sector. The industry currently carries a Zacks Industry Rank #236, which places it in the bottom 6% of around 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates grim near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperform the bottom 50% by a factor of more than 2 to 1.

The industry’s positioning in the bottom 50% of the Zacks-ranked industries is a result of a marginal earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are pessimistic about this group’s earnings growth potential. Over the past year, the industry’s earnings estimate for 2023 has plunged more than 58%.

Despite the prospects of the industry, we will present a few stocks that may hold their ground. But it’s worth taking a look at the industry’s shareholder returns and current valuation first.

Industry Top Sector and S&P 500

The Zacks Auto Retail and Wholesale Parts industry has outperformed the Auto, Tires and Truck sector and the Zacks S&P 500 composite over the past year. The industry has lost 4.3% over this period compared with the S&P 500 and the sector’s decline of 17.3% and 53.6%, respectively.

One-Year Price Performance

Industry’s Current Valuation

Since automotive companies are debt-laden, it makes sense to value them based on the EV/EBITDA (Enterprise Value/Earnings before Interest Tax Depreciation and Amortization) ratio.

Based on a trailing 12-month enterprise value to EBITDA (EV/EBITDA), the industry is currently trading at 53.78X compared with the S&P 500’s 11.83X and the sector’s 11.66X.

Over the past five years, the industry has traded as high as 56.35X and as low as 15.87X, with the median being at 23.28X, as the chart below shows.

EV/EBITDA Ratio (Past 5 Years)

2 Stocks to Watch

O’Reilly: O’Reilly is one of the noted retailers of automotive aftermarket parts, tools, supplies, equipment and accessories in the United States. The company has been generating record revenues for 29 consecutive years due to growth in the auto parts market. ORLY is poised to benefit from store openings and distribution centers in profitable regions. Strong cash flow generation supports the firm’s robust buyback program, thereby boosting investors’ confidence.

O’Reilly, which currently carries a Zacks Rank #3 (Hold), has a long-term expected EPS growth rate of around 13%. The Zacks Consensus Estimate for its 2023 earnings and sales indicates a year-over-year uptick of 12% and 5.3%, respectively. ORLY pulled off earnings beat twice in the last four quarters for as many misses, the average surprise being 7.5%.

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Price & Consensus: ORLY

AutoZone: AutoZone is one of the leading specialty retailers and distributors of automotive replacement parts and accessories in the United States. It has been generating record revenues for 24 straight years, and the trend is expected to continue. The company’s high-quality products, store-expansion initiatives and omni-channel efforts to improve the customer shopping experience are boosting its market share.

AutoZone, which currently carries a Zacks Rank #3, has a long-term expected EPS growth rate of 11.3%. The Zacks Consensus Estimate for fiscal 2023 earnings and sales indicates a year-over-year uptick of 13.4% and 5%, respectively. AZO’s earnings surpassed estimates in each of the trailing four quarters, the average surprise being 13.05%.

Price & Consensus: AZO

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