Pep Boys Hits a Bump in the Road

Auto maintenance and merchandise chain Pep Boys took a tremendous hit during Tuesday's trading on the back of a challenging earnings report. The company delivered a loss for its recently ended quarter, surprising most analysts and investors, and guided for difficult times ahead due to poor tire pricing. As is consistent within the industry, Pep Boys is growing its services division and seeing positive metrics, while merchandise is falling flat.

On one end, the U.S. auto portfolio holds a very high average age -- more than 11 years -- but at the same time, technologically advanced vehicles are discouraging folks from do-it-yourself repair tactics. Is Pep Boys experiencing short-term headwinds, or does the company need to change?

Pump the brakes
While the Street looked for an average of $0.05 per-share profit, Pep Boys delivered a $0.06 per-share loss in its fiscal fourth quarter. Sales were up just 0.2% (on an adjusted basis), driven by a mix of higher service sales (1.4%) and merchandise sales that plummeted more than 3% on a same-store basis.

Pep Boys is bringing 30 new service and tire centers online throughout 2014 in support of its strategy to grow the service side of the business

Omnichannel retailing, the idea of cross-selling and cross-promoting via digital and physical channels, is proving particularly successful for Pep Boys. The company encourages customers to make appointments and buy tires online, and then come into the service bays for maintenance and installations. Sales driven by omnichannel initiatives grew by 152% in the fourth quarter.

Ultimately, two things held Pep Boys back -- poor merchandising in the stores and lower retail tire pricing. Management noted that the latter is stabilizing but remains lower than the prior year. The crunch is felt on the top line. As far as the merchandise, it may be a necessary evil to get people into the higher-margin, higher-earning service bays.

The Road Ahead
The Street bemoaned management's comments about tire pricing keeping pressure on sales for the current quarter, but the focus should have been on the early results from the new concept service center in Tampa, Fla. (dubbed "Road Ahead"). Management noted that the store easily hit its target for 15% returns, and that the concept is being rolled out in markets across the country. This is the growth driver for Pep Boys, and this is what would justify a buy today.

Pep Boys isn't the market leader in the space -- Advanced Auto Parts is a much larger company with the similar idea to build out service centers around the country. That doesn't mean that Pep Boys isn't the better stock, but it's certainly more expensive at current levels. Advanced Auto Parts, while not likely to grow as quickly due to its sheer size, trades at 14 times forward earnings and holds an EV/EBITDA of 9.31 times. Pep Boys trades at 17.5 times earnings with an EV/EBITDA of 8.26 times. While there is a slight discount on its continuing operations, Pep Boys doesn't hold the most compelling valuation compared to its larger brethren.

The market may be wrong to sell off 14% of the stock, as Pep Boys is doing the right things to address industry trends, but it is still not yet a buy.

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