Looking back at our August automotive aftermarket investor conference, we would say the sentiment of those management teams participating was positive, perhaps even more so than we would have expected given the deterioration in consumer confidence over recent weeks. With the exception of those companies with greater exposure to tires (big ticket items = deferrals), we suspect that trends are holding up even against the difficult comparisons from a strong Q3’10 although we are also mindful that comparisons really don’t ease until Q1’12. We are optimistic that gas prices will retreat more appreciably in the coming weeks (outside of weather-related disruptions) and months based upon the current level of oil prices, which should help free up some much needed disposable income. And although miles driven may not be as important an indicator as in the past since the majority of these miles are now being driven on a much older vehicle, a recovery would likely provide a boost to store level traffic for both DIY and DIFM participants.
Our view remains that there will be pockets of volatility (outside of the macro gyrations) as investors digest the varying degrees of channel checks throughout Q3 and Q4, but overall we still think 2012 will be another solid year for the group and encourage investors to pick their buy spots but have exposure heading into next year.
In a period of weak economic growth, very elevated levels of un- and under-employment, and further deleveraging of household balance sheets, we believe underlying DIY demand fundamentals are likely to hang in fairly well over the intermediate term, outside of potential near-term shocks from higher gasoline prices and challenging yr/yr same store sales comparison. That said, we believe the wholesale parts distribution business remains by far the greater long-term opportunity for growth. Not only is the commercial/wholesale parts distribution market larger and more fragmented, but increasing vehicle complexity is likely to drive a larger share of aggregate maintenance and repair into the DIFM channel over the longer term.
From a management perspective, parts proliferation and inventory expansion continue to exert huge pressures on the automotive supply chain. That said, the larger players have done a solid job of finding ways to offset the capital intensity caused by slow inventory turnover rates through demand forecasting models, application of local VIO analyses, and greater utilization of supply chain finance programs to accelerate cash collection for suppliers while reducing net-owned inventory for the retailers and distributors. When interest rates increase, the higher cost to supply chain finance programs will be dealt with in much the same way as higher labor and raw material costs. However, we fear suppliers may bear the greatest burden.
In terms of the competitive landscape, of the roughly 35,000 auto parts stores in the United States, we expect to see the larger players continue to grow their store base although the total number of auto parts stores will likely remain unchanged (or even possibly shrink somewhat) as smaller competitors simply exit through attrition. We expect to see even greater consolidation within the still very fragmented professional service market, where only a handful of companies operate more than 1,000 locations in the United States out of a total base of more than 200,000 repair shops. We believe this trend is likely to provide a multi-year tailwind for those public companies with the scale, systems and access to capital necessary to capitalize on this development. For the suppliers, continued consolidation simply reinforces the need to have the most efficient manufacturing processes and lower possible cost structure in order to offset the increased buying power and leverage that downstream customers possess in pricing negotiations. The new car dealers remain a force to be reckoned with, and with new vehicle sales still at depressed levels the automotive retailers have become even more aggressive in their efforts to regain share in the service and parts business. We believe that the auto retailers are refocusing their efforts on providing the best customer service possible from the time a new vehicle is sold through the expiration of that new car’s warranty in order to maximize the possibility that they win the customer’s automotive service and repair business down the road. In addition, the auto retailers are also placing a greater emphasis on initiatives that promote frequent customer contact such as selling a greater portion of their new car customers extended service contracts and oil change packages.
About BB&T Capital Markets:
BB&T Capital Markets is a full-service investment banking firm that focuses on specific industries, including the Automotive Aftermarket. BB&T Capital Markets is a division of Scott & Stringfellow, LLC, member NYSE/FINRA/SIPC. Scott & Stringfellow is a wholly-owned nonbank subsidiary of BB&T Corporation, one of the nation’s largest financial holding companies with $155 billion in assets. Securities and insurance products or annuities sold, offered or recommended by Scott & Stringfellow are not a deposit, not FDIC insured, not guaranteed by a bank, not insured by any federal agency and may lose value.