Early '07 sales sluggish, but uptick on its way

Consumer deferrals in 2006 should translate into more service repairs later this year.

For 2007, we thought the aftermarket would receive a boost in general from receding gas prices along with increased miles driven that began in September; however, results so far have not indicated significant improvement.

Although there was modest improvement as gas prices declined, channel checks and recent data points suggest that sales trends remained somewhat sluggish as 2007 began. However, with the late January/early February cold snap, there has been an uptick, and these trends could be the positive spark the industry needs to have a better year in 2007.

Of the retailers and service providers recently reporting earnings, only O'Reilly and Monro Muffler had optimistic outlooks for the near term operating environment. Given what we believe to be the trickle-down economics of the automotive aftermarket, there is some potential strength in those sectors that count the service chain as their customer, such as commercial distributors and certain manufacturers.

As Figure 1 illustrates, same-store sales (SSS) for the retailers and service providers were soft for much of 2006, making for more favorable sales comparisons heading into this year. It's important to remember that the service chains began to experience sales softness in 2006 sooner than retailers, perhaps because consumers were pushing back some "at the margin" services to DIY simply to save money. That said, we expect to see trends at the retailers to lag in recovery by a couple of months, particularly in the DIY segment.

Most companies will begin to see very favorable comparisons starting in the second quarter of '07. In addition, the significant number of deferrals in 2006 should translate into demand for auto services this year. Stability in gas prices also should be a key factor, as it provides consumers with more flexibility in allocating dollars toward automotive needs, and boosts the number of miles driven.

More importantly, however, we think the majority of the companies we follow have been disciplined on costs. As we move through 2007, there could be greater-than-expected operating leverage because of a pickup in sales, as well as tighter expense controls. In our opinion, 2006 was a lost year in terms of growth. We believe patient investors, those looking out six to 12 months, are likely to find good buying opportunities in the aftermarket sector for 2007.

Notes: Stock Price and Operating Metrics as of 1/2/07. TEV = Total Enterprise Value (Market Cap. + Debt – Cash). EBITDA = Earnings Before Interest Taxes Depreciation and Amortization. DSO = Days Sales Outstanding. DPO = Days Payable Outstanding. Forward estimates are consensus as reported by Bloomberg. YTD = Year to Date. CY = Calendar Year. LTM = Last Twelve Months.

SOURCE: CAPITALLQ, BLOOMBERG.

Disclosures: BB&T Capital Markets makes a market in the securities of Monro Muffler Brake, Inc. and O'Reilly Automotive Inc. BB&T Capital Markets expects to receive or intends to seek compensation for investment banking services from Monro Muffler Brake, Inc. and O'Reilly Automotive Inc. in the next three months. An affiliate of BB&T Capital Markets received compensation from Monro Muffler Brake, Inc. and O'Reilly Automotive Inc. for products or services other than investment banking services during the past 12 months.