2023-08-05 02:28:02 ET
Summary
- LKQ offers automotive products and services, including collision replacement parts and recycled engines.
- LKQ business model is now more resilient than the past as management focused on productivity.
- LKQ should benefit from the State Farm program and improving supply chains.
Summary
LKQ Corporation ( LKQ ) offers automotive products and services. The Company provides alternative collision replacement parts, recycled engines, transmissions, replacement systems, components, and parts for the repair of automobiles and light, medium, and heavy-duty trucks.
I am recommending a buy rating as I expect LKQ to stay resilient throughout this tough macro cycle, supported by a more productive business model relative to the past. My DCF model, which assumes a conservative 7% EPS CAGR growth, suggests the share price should be worth $67 today, a 21% upside.
Financials / Valuation
Total revenue increased 3.2% y/y to $3.448 billion, with growth coming primarily from an increase of 4.8% y/y in organic revenue from Total Parts & Service. Within this, organic sales for Parts & Service increased 8.3% y/y in North America and 8.5% year-on-year in Europe. While the Self-Service market increased by 4.7% year-over-year, Specialty saw a decrease of 12.9%. As for both EBITDA and EBIT margin, both declined modestly vs last year, by 33bps and 19bps respectively. Diluted EPS came in at $1.09, flat vs last year but a slight improvement from 1Q23 of $1.04. I would also point out here that LKQ has grown EPS at 8% pre-covid (2014 to 2019).
Based on my view of the business, LKQ should be able to grow EPS at a high single-digit CAGR for the growth period (I modeled 7% to be on the safe side). LKQ has historically grown its top line at a 12% CAGR between FY22 and FY12. I do not expect the same level of growth moving forward, as the revenue base is much higher today. The available room for margin expansion should also be lower compared to the past. As such, a high single digit EPS growth rate is more likely.
Moneychimp
Comments
LKQ had a very successful second quarter, reporting increases in revenue, EBITDA, and EPS. The North American and European Parts & Service markets have experienced organic revenue growth. Although the EBITDA margin went down year over year, it went up quarter over quarter by 30bps, thanks to a more favorable mix of margins in the North American Parts & Service and European segments, which more than compensated for the Self-Service segment's much weaker margin due to lower scrap and precious metals prices.
With supply chains continuing to improve and fill-rates getting closer to optimal levels (mid-90% compared to high-80% a year ago), North American sales of parts and services grew by 8.3% year over year organically. Moreover, a 400 bps y/y increase in Q2 alternative product usage has been a positive tailwind on growth so far this year as higher repair costs and better in-stocks have contributed to this trend. I believe the segment will reap the benefits of the State Farm program in the near to medium term. In the 2Q23 earnings call , management estimated that full implementation of the program across the country could generate $125 million in additional revenue. For context, State Farm is the largest automobile insurance company in the US ( 2Q22 earnings ), and they represent around 18% market share (2Q22 earnings) in the aftermarket collision parts demand. With State Farm restarting the use of aftermarket collision parts, this is a big news for a big player like LKQ as they likely top the list as the vendor of choice. Consequently, I expect margins to improve accordingly, with further support by easing freight costs.
In Europe, where demand remained robust and LKQ continued to gain market share in the highly fragmented mechanical parts market, organic revenue grew by high single digits to double digits across Benelux, Germany, and Eastern Europe. Even though localized areas of weakness are to be expected in light of the forthcoming regional recessions, I believe LKQ will prove more resilient than in the past because of the extensive measures taken to boost productivity.
“The inflationary environment as I indicated over in Europe is much more intense than it is here in the US. And so they've needed productivity gains to offset a lot of that increase and allow us to actually get to a lower SG&A percent as compared to revenues.” 2Q23 earnings
The fact that LKQ has been able to grow its business both in terms of volume and price suggests that the company is nimble enough to adjust to changing market conditions and maintain its foothold.
What makes me nervous is that Self-Service and Specialty are still feeling the effects of declining commodity values and RV weakness. EBITDA margin dropped 390 basis points to 9.5% as Specialty organic sales dropped 12.9%. Also, the RV industry is still feeling the effects of historically low wholesale shipments and towing, which have been the main restraints on expansion. Management mentioned a -40% y/y decline in wholesale shipments for the RV industry during the 2Q23 call, and I believe this will continue to be a drag on LKQ for the remainder of FY23. Meanwhile, the decline in the value of precious and commodity metals caused the Self-Service EBITDA margin to fall by 11pts, to 4.1%. I note that Self-Service margin should stabilize once the metals' price recover, but I do not have any insights into that.
Risk & conclusion
LKQ has shown resilience during tough this macro cycle, supported by a more productive business model and organic revenue growth in its Parts & Service markets in North America and Europe. Management's efforts to boost productivity and offset inflationary pressures in Europe should further enhance LKQ's ability to weather challenges. While there are risks associated with declining metal prices (impacting Self-Service segment) and weakness in the RV industry (reduced volume demand for LKQ services), the overall outlook remains positive, especially with the potential benefits from the State Farm program and improving supply chains.
For further details see:
LKQ Corp Q2 Earnings: Resilient Business Model Should Help Tide Over Macro Cycles