Advance Auto Parts (AAP): A Dividend in Peril Amid Earnings Turbulence

The auto parts retailer's dividend yield of 1.9% may appear tempting at first glance, but beneath the surface lies a precarious financial structure that raises serious questions about the sustainability of its payouts. Advance Auto Parts (AAP) has slashed dividends by over two-thirds since 2022, signaling a company struggling to balance shareholder returns with deteriorating profitability. For income investors, this is a cautionary tale of overleveraged optimism colliding with harsh market realities.

Dividend Cuts: A Pattern of Retreat

AAP's dividend history since 2020 reveals a stark trajectory of retreat. After maintaining a stable $1.00 annual dividend through 2022, the company abruptly cut payouts by 66.7% in 2023 to $0.33 annually. A further 50% reduction in 2024 trimmed the dividend to $0.50 per share, with estimates suggesting another 25% drop to $0.38 in 2025. These cuts reflect a fundamental shift: AAP is no longer a reliable income generator but a company prioritizing liquidity amid mounting financial pressures.

The structural flaw is clear: dividends now exceed earnings. As of late 2024, AAP reported a trailing twelve-month EPS of -5.63, with a payout ratio of -17.8%—a mathematical impossibility for a sustainable dividend. The company is effectively borrowing from future earnings (or debt) to fund payouts, a strategy that cannot endure indefinitely.

Earnings Volatility: The Root of Instability

AAP's profitability has been a rollercoaster. After posting EPS of $6.48 in 2021, the company saw earnings collapse to -$5.63 over the trailing twelve months. This volatility stems from two key factors:

1. Cost Pressures: Rising labor, freight, and raw material costs have eroded margins. Even in Q1 2025, adjusted diluted EPS turned negative (-$0.22), though GAAP earnings remained positive at $0.40.
2. Top-Line Stagnation: Comparable store sales growth has stalled, with customers increasingly turning to cheaper alternatives or online competitors.

Analysts' 2025 EPS guidance of $1.50–$2.50 hinges on a recovery that AAP has failed to deliver for years. Should these forecasts miss, the dividend could face further cuts.

Further evidence of AAP's earnings-driven volatility emerges from historical trading patterns. A backtest analyzing the performance of buying AAP shares five days before each quarterly earnings announcement and holding for 20 trading days from 2020 to 2025 revealed a total return of -16.95%, with a maximum drawdown of -53.49%. This strategy underperformed the broader market, underscoring the unpredictability of timing trades around earnings releases.

Cash Flow: The Silent Crisis

Free cash flow (FCF) has been negative for much of the past five years, compounding concerns. A company with negative FCF cannot sustain dividends without either taking on debt or diluting shareholders. AAP's debt-to-equity ratio has climbed to 0.6x, signaling increased leverage to plug cash shortfalls.

Near-Term Forecasts: A Fragile Optimism

Management remains bullish, citing cost-cutting and a renewed focus on core auto parts. However, the auto retail sector faces structural headwinds:
- Electric Vehicle Transition: EVs require fewer parts, threatening AAP's traditional business model.
- E-Commerce Disruption: Competitors like AutoZone and O'Reilly are digitizing faster, squeezing AAP's market share.

Even if AAP meets its 2025 EPS target, the payout ratio would still exceed 60%—a risky level for an industry with low barriers to entry and price sensitivity.

Investment Thesis: Proceed with Extreme Caution

While AAP's 1.9% yield may attract dividend investors, the risks far outweigh the rewards:
1. Dividend Reliability: The payout has been cut three times in five years. There is no guarantee it won't be slashed again.
2. Valuation Risks: The stock trades at 15x forward EPS, a premium to its five-year average of 12x, despite shaky fundamentals.
3. Alternatives: Competitors like O'Reilly (ORLY) offer higher yields (3.2%) with stronger balance sheets and better margins.

Actionable Advice:
- Avoid AAP for income portfolios. The dividend is a ticking time bomb.
- Consider shorting the stock if earnings miss estimates or FCF remains negative.
- Monitor Q3 2025 results closely—failure to stabilize profitability could trigger a sell-off.

Conclusion

Advance Auto Parts is a cautionary case of a dividend policy outpacing reality. Its cuts since 2022, negative earnings, and deteriorating cash flow paint a picture of a company clinging to shareholder payouts despite eroding fundamentals. While near-term EPS forecasts offer a sliver of hope, structural risks—cost inflation, EV disruption, and competitive pressures—make AAP a high-risk bet. Income investors would be wise to look elsewhere for reliable returns.