Executive Summary / Key Takeaways

• Advance Auto Parts is undergoing a significant operational turnaround focused on simplifying the business and improving core retail fundamentals following the divestiture of Worldpac and strategic store closures.
• The company has reaffirmed its full year 2025 guidance, targeting adjusted operating income margin of 2% to 3%, and has set a clear objective to reach approximately 7% adjusted operating margin by the end of fiscal 2027, driven primarily by operational efficiencies.
• Strategic initiatives across merchandising, supply chain, and store operations, supported by investments in operational technology, are expected to drive significant margin expansion and improve sales productivity, addressing the current performance gap relative to peers.
• A strengthened balance sheet and enhanced liquidity position, largely from the Worldpac sale proceeds, provide the financial flexibility to fund strategic investments and support the targeted reduction in debt leverage to 2.5 times by 2027.
• While facing macroeconomic headwinds impacting consumer spending and potential risks from tariffs and execution complexity, management emphasizes that the core drivers of the turnaround are within their control, focusing on disciplined execution of the strategic plan.

A New Chapter for Advance Auto Parts

Advance Auto Parts, Inc. (AAP) stands as a long-tenured participant in the North American automotive aftermarket, boasting a history stretching back 93 years. Serving both the professional installer (Pro) and do-it-yourself (DIY) customer segments through its blended box model under the Advance Auto Parts and Carquest banners, the company operates within a large and relatively stable industry. The market benefits from secular tailwinds, including a growing U.S. vehicle fleet with an increasing average age, currently standing at 12.8 years, and consistent miles driven, which necessitate ongoing maintenance and repair. Despite these favorable industry dynamics, AAP has faced operational challenges, leading to a performance gap compared to some of its key competitors.

Recognizing the need for decisive action, AAP initiated a comprehensive strategic and operational review in late 2023. This review culminated in a plan to simplify the business and sharpen its focus on core retail execution. A pivotal outcome was the divestiture of the Worldpac business in fiscal 2024 for $1.5 billion in cash. This move was designed to streamline operations, enhance the balance sheet, and allow the company to concentrate resources on its blended box model. Simultaneously, the review affirmed the value of the Canadian operations, which were retained due to their strong performance and alignment with the U.S. business.

The strategic pivot is underpinned by three core pillars: Merchandising Excellence, Supply Chain Transformation, and Store Operations Optimization. These pillars are not merely conceptual but are tied to specific initiatives, operational metrics, and quantifiable targets aimed at improving efficiency, productivity, and customer service. The company's approach to technology is centered on enabling these operational improvements, rather than developing a distinct product technology. Investments in operational technology, such as completing the rollout of a single Warehouse Management System (WMS) across all distribution centers in Q3 2024 and leveraging technology to automate key processes in assortment management, are foundational to improving inventory accuracy, tracking, and flow. The goal is to drive tangible benefits like increased labor productivity (measured by lines per hour, which saw low single-digit improvement in Q1 2025) and expedite strategic initiatives like the assortment framework rollout.

Strategic Pillars: The Foundation for Turnaround

The turnaround narrative is built upon the execution of initiatives within AAP's three strategic pillars. In Merchandising, the focus is on expanding parts availability and securing quality products at competitive costs. New leadership is driving a shift towards collaborative vendor partnerships aimed at mutual growth. The company is conducting extensive line reviews and implementing a new assortment framework designed to better align inventory with market-specific needs. This framework, piloted in late 2024 and expanding to the top 50 Designated Market Areas (DMAs) by the end of 2025 (with 30 expected by August), has shown promising early results, with an estimated uplift of nearly 50 basis points in comparable sales growth observed in pilot DMAs. Efforts to improve SKU depth are ongoing, with the store availability KPI reaching the mid-90s percentage range in Q1 2025, a sequential improvement of approximately 200 basis points. Strategic vendor negotiations are expected to yield greater than 50 basis points of annualized cost reductions starting in the second half of 2025.

Supply Chain Transformation is critical to improving efficiency and speed. The company is consolidating its distribution network from 38 DCs to a target of 12 large facilities by the end of 2026. This consolidation, along with the fully implemented single WMS, is expected to drive labor productivity and optimize inbound/outbound processes. A new routing framework is being implemented in stages throughout 2025 to improve transportation efficiency, with cost savings anticipated by late 2025. The development of a multi-echelon network, centered around Market Hubs, is accelerating. As of Q1 2025, 21 market hubs are operational, with a target of 60 by mid-2027. These hubs, stocking 75,000-85,000 SKUs, are designed to significantly increase same-day parts availability for surrounding stores. Markets serviced by these hubs have shown an estimated comp uplift of nearly 100 basis points through Q1 2025, reinforcing confidence in this model.

Store Operations are being optimized to improve service levels and labor productivity. The company is testing a standardized operating structure in approximately 10% of stores, which guides labor scheduling and asset allocation (like delivery trucks and driver hours). This model is expected to roll out company-wide by the end of 2025. Initiatives focused on the Pro business, including redesigned incentives and training for frontline teams, are showing results, with Pro comparable sales growing in the low single-digit range in Q1 2025 and demonstrating 8 consecutive weeks of positive growth in the U.S. Delivery time for Pro customers has been reduced by approximately 10 minutes compared to last year, with a goal of consistently delivering parts within 30-40 minutes. For DIY customers, efforts include enhanced training, reallocation of roles, and a new marketing campaign, contributing to a stabilization in units sold per transaction.

Recent Performance: Signs of Progress Amidst Headwinds

Recent financial results reflect the ongoing transformation and the impact of strategic actions and external factors. In the first quarter of fiscal 2025, net sales from continuing operations decreased by 6.8% year-over-year to $2.583 billion, primarily driven by lower sales volume resulting from the store closures executed under the 2024 Restructuring Plan. Comparable store sales declined by 0.6%. Gross profit margin for Q1 2025 was 42.9%, a decrease of 50 basis points compared to the prior year, mainly due to lower margin liquidation sales from closed stores. Selling, general and administrative (SG&A) expenses as a percentage of net sales increased significantly to 48.0%, primarily due to $118 million in restructuring and related expenses. Excluding these costs, SG&A still deleveraged year-over-year. Despite these pressures, the company reported a net income from continuing operations of $24 million, compared to $17 million in the prior year, benefiting from a significant discrete tax benefit. Management highlighted that Q1 results were better than expected, with adjusted operating loss narrowing significantly compared to the prior quarter, signaling sequential improvement.

Full year 2024 results for continuing operations saw net sales of approximately $9 billion and comparable store sales declining by 0.7%. Adjusted operating income margin was between 25 and 75 basis points. Performance in the second half of 2024 was impacted by softness in the consumer spending environment, leading to maintenance deferrals, and specific events like hurricanes and a system outage. Q4 2024 saw a 1% comparable sales decline, with gross margin impacted by inventory adjustments and liquidation sales. These results underscore the challenging operating environment and the costs associated with the initial phases of the restructuring.

Balance Sheet Strength and Liquidity

A key outcome of the strategic review and the Worldpac sale is a significantly strengthened balance sheet and enhanced liquidity. The company's core objective is to reduce the debt leverage ratio from over 4 times at the end of Q3 2024 to approximately 2.5 times by the end of 2027, through a combination of debt repayment, lease obligation reductions, and improved profitability.

As of April 19, 2025, cash and cash equivalents stood at $1.672 billion. The Worldpac transaction generated net proceeds estimated at approximately $1.45 billion, providing substantial capital. The estimated cash expenses associated with the store and DC closures are now expected to be approximately $300 million in total, with the majority of the remaining balance incurred in Q1 2025 ($90 million was spent in 2024). This enhanced cash position provides the financial flexibility necessary to fund strategic investments and navigate the turnaround.

The company maintains access to an undrawn revolving credit facility with $885 million in borrowing availability as of April 19, 2025. Recent amendments to the credit agreement provide flexibility related to financial covenants during the restructuring period. While confirmed obligations under supplier finance programs remain substantial at $3.2 billion, the company was in compliance with its financial covenants as of April 19, 2025. The strong cash position is expected to fund planned capital expenditures of approximately $300 million in 2025, targeted at strategic initiatives, IT, store, and supply chain infrastructure.

Outlook: Targeting Profitability and Growth

Advance Auto Parts has reaffirmed its full year 2025 guidance, signaling confidence in its ability to execute against its strategic plan despite ongoing external pressures. For 2025, the company expects net sales between $8.4 billion and $8.6 billion, reflecting the impact of store closures. Comparable sales growth is projected in the range of 50 to 150 basis points on a 52-week basis, with sequential improvement anticipated throughout the year, driven by strategic initiatives and easier comparisons in the second half. Adjusted operating income margin is guided to be between 2% and 3%, representing a significant step up from recent performance. This margin expansion is expected to be primarily driven by gross margin improvements from product cost savings and supply chain efficiencies, along with SG&A favorability from labor productivity and cost savings from asset optimization. Adjusted diluted EPS is guided between $1.50 and $2.50, and free cash flow is expected to be negative $85 million to negative $25 million, including the remaining closure costs.

Looking further ahead, the company has set a clear objective to achieve approximately 7% adjusted operating income margin by the end of fiscal 2027. This ambitious target implies an expansion of approximately 500 basis points from the Q3 2024 adjusted operating margin, expected to be driven by the full realization of benefits from merchandising excellence, supply chain transformation, and store efficiency initiatives. The plan assumes fiscal 2027 gross margin in the mid-40s range and SG&A below 40% of sales. While the plan is based on comparable sales growth below historical industry levels, management believes the identified operational efficiencies within their control are sufficient to drive this margin expansion. The company also plans to return to growth through new store openings, targeting an annual cadence of 100 stores per year over time, focusing on high-density markets where it holds a strong competitive position.

Competitive Landscape and Positioning

The automotive aftermarket is a highly competitive and fragmented market. AAP competes directly with large national players like O'Reilly Automotive (ORLY), AutoZone (AZO), and Genuine Parts Company (TICKER:GPC - including NAPA Auto Parts), as well as smaller regional players and indirect competitors like online retailers. While AAP holds a significant footprint, its recent financial performance, particularly in terms of operating margins and growth rates, has lagged behind peers like ORLY and AZO, which consistently demonstrate higher profitability and efficiency metrics (e.g., ORLY and AZO often report operating margins in the high teens or low twenties, significantly above AAP's recent performance).

AAP's strategic response is not to compete solely on scale or price leadership across the board, but to leverage its existing assets and operational technology to improve execution in core areas. By concentrating its footprint in markets where it has #1 or #2 density (over 75% post-closures), AAP aims to enhance its "right to win" through better service speed and parts availability, areas where it has historically faced challenges compared to more efficient competitors. The focus on the blended box model, serving both Pro and DIY from the same location, remains central. Operational technology investments, such as the WMS and assortment management systems, are intended to close the efficiency gap by improving inventory accuracy, reducing costs, and enabling faster service, thereby enhancing its competitive position against rivals known for their logistical prowess. While the margin gap to peers is substantial, AAP believes the fragmented nature of the market and its focused strategy in core geographies provide ample opportunity for profitable growth without needing to take share directly from the largest competitors. The goal is to improve its own operational performance to levels more commensurate with a leading industry player.

Risks to the Turnaround

Despite the clear strategic plan and management's confidence, several risks could impact the pace and success of the turnaround. The macroeconomic environment remains volatile, with potential for continued pressure on consumer spending due to inflation and economic uncertainty. This could lead to further deferral of maintenance or trading down to lower-margin products, impacting sales and profitability, particularly in the DIY segment. Geopolitical factors, including new global trade tariffs on imports from key sourcing countries like China and Mexico, pose a risk of increased product costs. While AAP is implementing mitigation strategies like sourcing diversification and price adjustments, the ultimate impact remains uncertain and could affect margins or demand elasticity.

Execution risk is inherent in a transformation of this magnitude. The complexity of consolidating distribution centers, rolling out new systems and operating models, and optimizing the store footprint while simultaneously running the day-to-day business could lead to disruptions. Variability in the timing of realizing the expected benefits from these initiatives could impact financial performance in the near term. Furthermore, a potential downgrade in the company's credit ratings could increase borrowing costs and potentially impact participation in supplier finance programs, which could strain working capital and liquidity. Management acknowledges these risks and emphasizes the importance of disciplined execution and accountability against key performance indicators to navigate them.

Conclusion

Advance Auto Parts is embarking on a critical phase of its turnaround journey, marked by decisive actions to simplify its structure, optimize its asset base, and refocus on core retail fundamentals. The divestiture of Worldpac and strategic store closures, completed ahead of schedule, have provided enhanced liquidity and a clearer operational focus on the blended box model. Supported by investments in operational technology and driven by initiatives across merchandising, supply chain, and store operations, the company has laid out a credible plan to close its significant operating margin gap relative to industry peers.

The reaffirmed 2025 guidance and the ambitious 2027 target of approximately 7% adjusted operating margin provide a clear roadmap for investors, underpinned by expected improvements largely within management's control. While macroeconomic headwinds and execution complexities present challenges, the company's strengthened balance sheet offers the necessary financial flexibility to fund the transformation and pursue future growth opportunities, including a return to new store expansion. The success of AAP's turnaround hinges on disciplined execution of its strategic pillars, leveraging operational technology to drive efficiency and productivity, and effectively positioning itself within the competitive landscape to capture its share of the resilient automotive aftermarket.