Advance Auto Parts has had an impressive run over the past six months as its shares have beaten the S&P 500 by 26.3%. The stock now trades at $60.50, marking a 31.7% gain. This was partly due to its solid quarterly results, and the run-up might have investors contemplating their next move.

Is there a buying opportunity in Advance Auto Parts, or does it present a risk to your portfolio? See what our analysts have to say in our full research report, it’s free.

Why Do We Think Advance Auto Parts Will Underperform?

We’re happy investors have made money, but we don't have much confidence in Advance Auto Parts. Here are three reasons why we avoid AAP and a stock we'd rather own.

1. Flat Same-Store Sales Indicate Weak Demand

Same-store sales show the change in sales for a retailer's e-commerce platform and brick-and-mortar shops that have existed for at least a year. This is a key performance indicator because it measures organic growth.

Advance Auto Parts’s demand within its existing locations has barely increased over the last two years as its same-store sales were flat.

2. Shrinking Operating Margin

Operating margin is a key profitability metric because it accounts for all expenses necessary to run a store, including wages, inventory, rent, advertising, and other administrative costs.

Looking at the trend in its profitability, Advance Auto Parts’s operating margin decreased by 10.4 percentage points over the last year. Advance Auto Parts’s performance was poor no matter how you look at it - it shows that costs were rising and it couldn’t pass them onto its customers. Its operating margin for the trailing 12 months was negative 10.1%.

3. Short Cash Runway Exposes Shareholders to Potential Dilution

As long-term investors, the risk we care about most is the permanent loss of capital, which can happen when a company goes bankrupt or raises money from a disadvantaged position. This is separate from short-term stock price volatility, something we are much less bothered by.

Advance Auto Parts burned through $245.2 million of cash over the last year, and its $3.67 billion of debt exceeds the $1.67 billion of cash on its balance sheet. This is a deal breaker for us because indebted loss-making companies spell trouble.

Unless the Advance Auto Parts’s fundamentals change quickly, it might find itself in a position where it must raise capital from investors to continue operating. Whether that would be favorable is unclear because dilution is a headwind for shareholder returns.

We remain cautious of Advance Auto Parts until it generates consistent free cash flow or any of its announced financing plans materialize on its balance sheet.

Final Judgment

We cheer for all companies serving everyday consumers, but in the case of Advance Auto Parts, we’ll be cheering from the sidelines. With its shares outperforming the market lately, the stock trades at 28.2× forward P/E (or $60.50 per share). This valuation tells us a lot of optimism is priced in - you can find more timely opportunities elsewhere. We’d recommend looking at a top digital advertising platform riding the creator economy.

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