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Pep Boys No Longer Leaking Oil, But Stock's Expensive

Given recent improvements last quarter in both gross margin and operating margin, which advanced by 30 basis points and 10 basis points, respectively, I'm not expecting a disaster. But a bottom line miss wouldn't be a surprise, either. But investors shouldn't make the mistake and be so focused on the bottom line here -- not to the extent that it "makes or breaks" Pep Boys' momentum.

Remember, this company is still in the midst of bringing operational efficiency to its model. I'm saying to let the company off the hook for missing its targets. But more pressing issues must be addressed, including the fact that Pep Boys stores are often considered to be in "undesirable locations." These and other factors have hurt sales.

I'm also curious to hear what the company says about the progress it is making to bring efficiency in space utilization. In other words, I believe that many Pep Boys locations have significantly more space than the company knows what to do with.

To that end, in lieu of the near-term bottom line performance, investors should instead focus their attention on the company's guidance as well as what management says regarding future comp growth and the direction of the company's higher margin service business, which has been dinged in the past by (among others) Wal-Mart. But the future seems not as slippery.

While investors now have every right to be encouraged by the company's direction, keep in mind that this has also become a story about valuation. With the stock already up close to 30% on the year and trading at its 52-week high, I would be taking some money off the table here.

With that said, it wouldn't surprise me to see the stock sell-off even after a better-than-expected earnings performance. Even when looking at Pep Boys' fiscal 2014 EPS estimates, which cuts the P/E by one-third to 17, the stock is still trading 3 points higher than both Auto Zone and Advance Auto Parts, which trades at fiscal 2014 EPS estimates of 13.
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