Monroe(NASDAQ:MNRO) has fallen by about a third over the past three months as consumers buy fewer goods, leading to weak operating metrics and management’s reluctance to provide forward guidance.us We believe the company reported resilient results in the first quarter against a challenging macro backdrop, but we believe sequential weakness is ahead, particularly as gross margin gains weaken from the divestment of its wholesale business. We believe Monro’s long-term prospects remain intact as the average age of U.S. vehicles increases, but near-term challenges remain, particularly in the tire market, which remains its largest source of revenue. Additionally, we wait to see a solid and sustained track record of outperformance among its 300 underperforming smaller stores and adopt a wait-and-see strategy. Start with neutral.
Monro is a leader in retail tires and automotive services, operating a chain of approximately 1,300 independently owned centers and approximately 80 franchised locations in more than 30 states. It dominates primarily in the northeastern United States, with growing influence in the southern and western United States.
It provides a wide range of routine maintenance services for brakes, drivetrains, wheel alignments and other components in passenger cars, trucks and light vans, servicing approximately 5 million vehicles annually. The tire division is the largest revenue contributor, accounting for about half of revenue, while maintenance services have remained largely stable over the years.
Revenue by Product (FY2023)
Operating vehicles in the United States have shown strong growth over the years, with rapid sales growth from 2013-2017 leading to a surge in the number of operating vehicles. This bodes well for the aftermarket industry and for Monro, which targets vehicles between 6 and 12 years old that require regular maintenance and repairs.
Monro operates in a highly fragmented $311 billion industry (approximately 80% of the U.S. aftermarket automotive industry) with a broad portfolio of motor vehicle dealers, general repair shops, tire dealers, specialty repair and oil change stations. Several local, regional and other gas stations, as well as several independent garages, have more than 136,000 gas stations across the United States, providing a variety of after-sales services.
Distribution of outlets in the United States (2022)
Q1 earnings and Q2 preview
MNRO reported weak first-quarter results, with sales down 6.5%, primarily due to the divestment of its wholesale tire and distribution assets. The company reported that peer sales growth was flat at 0.5%, with about 300 underperforming centers performing relatively well, with peer sales growth of about 1%. On a monthly basis, the company’s comparative sales continued to decelerate, with the company’s April, May and June comparative sales growth at 2.4%, 0.7% and (1.6%) respectively, while the July comparison (as of July 22) also remained positive The 0.6% was supported by a lower base (comparative sales fell 0.7% a year ago). On the product side, the tire business remained the largest contributor to total sales (47% of total sales in the first quarter, compared with an average contribution of about 50%), growing only 1% year-on-year, while maintenance services grew 3% year-on-year, This was offset by declines in brakes (-2%), alignment (-2%) and front-end (-9%).
Gross margin remained flat primarily due to a 220 basis point gain from the wholesale divestiture and lower occupancy costs, which were largely offset by higher material costs and wage increases. SG&A deleveraged 220 basis points due to higher store expenses and sticky fixed costs from lower sales, resulting in an operating margin of 5.3% in the quarter compared with 7.5% last year. The company reported earnings of $0.31 per share, missing analysts’ expectations of $0.39.
The company posted comparable sales growth in the low to mid-single digits this year, driven by strong performance at 300 underperforming stores. We believe this could be challenging given the rather weak macroeconomic and demand headwinds, especially in the replacement tire market, which is MNRO’s largest revenue contributor and a high-margin market. The U.S. Tire Manufacturers Association (USTMA) lowered its February 2023 replacement tire shipment guidance to 325.9 million units, compared with its previous forecast of 334.2 million units in 2023, citing weaker trends.
Tire shipment forecast
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We believe maintenance services will continue to drive sales acceleration due to soft new vehicles due to higher sticker prices and an increase in the average age of vehicles requiring scheduled maintenance services. That’s the highest annual gain since 2008-2009, when recessionary pressures led to lower demand for new cars.
In addition, labor and technical personnel shortages will continue to drive up wage costs and competition among companies to retain talent and improve customer service, which may further erode gross margins.
We believe tire accessories sales will post low-single-digit declines in the second quarter due to lower traffic volumes, while maintenance parts sales will continue to grow in the low-single digits, with brakes and alignment systems seeing low-single-digit declines. Single-digit decline. We expect gross margin to decline approximately 200 basis points year-over-year due to higher product costs and deleveraging of SG&A expenses due to lower sales and sticky fixed costs, and assume an operating margin decline of 300 basis points.
Monero is cheaper on paper compared to its peers and historical averages. It trades at 9.0x on an EV/Fwd EBITDA basis, one of the cheapest compared to peers, and on a price/TTM cash flow basis it trades at 4.1x, one of the cheapest. On a P/E basis, it trades at 18x forward P/E, while the remaining 4x appears cheaper.
We believe the relative undervaluation is due to the company’s tepid outlook, as forward forecasts for revenue, earnings before interest, taxes, depreciation, and amortization (EBITDA) and earnings per share (EPS) place it at the bottom of the barrel compared to peers.
We believe that the long-term prospects of the automotive aftermarket are intact due to the increasing age of vehicles, with 74% of vehicles expected to be more than 6 years old by 2028, which will continue to drive strong growth in aftermarket sales. However, we believe near-term challenges remain, particularly for its tire business, and eagerly await how its tire business develops and its track record of operational outperformance from its small/underperforming stores.
Risks to ratings include
1) Monro operates in a highly competitive and fragmented automotive repair market with multiple local and regional players as well as gas stations and hypermarkets
2) A prolonged economic slowdown could severely impact its business operations as customers tighten their spending
3) The surge in electric vehicles will lead to reduced demand for services, which in turn will lead to lower service revenue
4) Due to labor shortages, companies may not be able to retain talent and may have to pay higher wages, resulting in lower gross profit margins
5) Upside risks to the rating include significant growth in maintenance revenue due to increasing vehicle age, improvement of underperforming stores, and increased stock buybacks or dividends to drive shareholder value
We believe Monro has strong brand resonance in a highly competitive and fragmented market and is well positioned for long-term growth. However, we see significant downside risks to management’s optimism, and we expect revenue to decline slightly this year due to weakness in the tire business. It remains one of the heavily shorted stocks, with short interest at around 10%, and we believe that while the current valuation may look attractive and the dividend yield is good, its ability to maintain its dividend and limited buybacks exists Significant downside risk Future activity (only a third of shares remain in the current share buyback program) may not provide much support to the share price. Start with neutral.