Advance Auto Parts has been lagging its peers in the U.S. automotive parts industry as it has struggled to get products to customers in a quick and cost-effective way. But Jeffrey Smith, CEO and CIO of the New Yorkbased activist hedge fund firm Starboard Value, believes the company has potential that could nearly double its stock price.
That was Smiths pitch Wednesday in Toronto at the Sohn Canada Conference, where he explained the thinking behind Starboards new, 3.7 percent stake in AAP, which it disclosed the night before. The Roanoke, Virginiabased company has been having a tough ride, but its not for lack of scale, according to Smith. AAPs sales are nearly as large as those of its biggest rival, AutoZone, but the company has trouble with execution. Where some would see a short, Smith sees opportunity.
We actually see a discounted multiple compared to its peers, which is really attractive for us as shareholders who can get actively involved and push for change to narrow that gap, Smith told the crowd at the investor conference.
To that end, Starboard plans to push AAP to increase margins by 600 to 750 basis points. AAPs earnings before interest, taxes, depreciation and amortization amounted to 12.4 percent of revenue in 2014, well behind AutoZones 22 percent and OReilly Automotives 20.3 percent. Smith also wants the company to revamp its supply chain strategy and potentially sell off some noncore assets, such as Worldpac, an automotive equipment importer based in Newark, California. The primary issues Smith hopes to address are supply and efficiency: AAPs competitors tend to stock more parts and are able to deliver them to customers typically automotive service stations more quickly.
Several years ago Springfield, Missouribased OReilly was in a similar situation when management launched a drive to improve margins. OReilly is now inching up on the leader, Memphis, Tennesseebased AutoZone.
Its becoming more and more inexcusable for Advance to allow this margin discrepancy to continue, and were going to encourage and work with the management team to make sure these margins move up to best in class, similar to the way OReilly did, Smith said. The hedge fund firm is expecting that the process will take the next several years, he added.
Smith is known for leading proxy fights against boards that dont bend easily to shareholder demands, but he said Wednesday that AAP management has promised to make changes. Investors certainly greeted the news with enthusiasm. The stock jumped by $19, or 11.1 percent, on news of the Starboard investment and closed Wednesday at $189.53. It edged up to $192.04 on Thursday. Smith said he believes AAP stock could climb to more than $350.
Why auto parts at all? Drivers are increasingly looking to the experts for car repairs instead of buying parts to do it themselves. Smith pointed out that the so-called do-it-for-me part of the business which accounts for 57 percent of AAPs revenue is quickly outpacing the do-it-yourself side of things as car parts last longer and become more complex. The business is also fairly safe from e-commerce giants such as Amazon that have taken the middlemen out of many industries; time is vital for car repairs, and customers cant wait for a delivery.
The Sohn audience also heard David Zorub, portfolio manager at New Yorkbased BlueMountain Capital Management, explain his firms bet against Mattel. The El Segundo, Californiabased toy maker will likely fall short of profit expectations because of sluggish legacy brands and fading new ones, according to Zorub. Mattels Monster High dolls are losing their allure, and Barbie is the companys problem child, failing to garner a following among Millennial moms, he said. Mattel could be a potential activist target down the road, but Zorub told the crowd that current conditions dont warrant making such a bet. BlueMountain expects sales to be $5.1 billion in 2016, behind the consensus forecast of $5.6 billion, and predicts earnings will come in well below the $710 million consensus, at closer to $400 million.
Cliff Robbins, founder and CEO of Greenwich, Connecticutbased Blue Harbour Group, discussed his firms June decision to bump up its stake in agriculture equipment manufacturer AGCO Corp., to 7.5 percent. Robbins told the conference he hoped the Duluth, Georgiabased company would benefit from consolidation in the agriculture equipment market and an increase in global demand for food. AGCOs hidden opportunity, however, is the fact that it gets 98 percent of its profits from Europe, where the agriculture market is steadier and more diversified than in the U.S. Robbins said he believes AGCOs stock is undervalued because it is based on its U.S. performance.