Summary
- LKQ Corporation has long been regarded as an M&A machine.
- After a strong track record in the 2010s, the company is on the hunt for deals again after a period of a pause.
- I like the long-term LKQ Corporation performance, as valuation remains very reasonable here.
It has been a while since I last looked at shares of LKQ Corporation ( LKQ ) . In fact, it was late 2017 when the company acquired Stahlgruber to expand its operations in Germany.
At the time, the deal was the latest to add to an M&A track record which started soon after the company was founded in 1998, as the business went public as soon as 2003. At the time, shares traded at a stock-adjusted price level of $2 per share (adjusted for multiple stock splits which followed ever since).
A Recap
Late in 2017, shares of LKQ Corporation had seen strong momentum during the year, with shares trading at $40 at the moment of writing. Part of the great momentum has been the result of continued M&A efforts, as the company in its history has made 200 deals to play its role as a consolidator in a fragmented market, although deals got bigger over time.
The outcome of this was a huge conglomerate of distributors of vehicle products such as replacement parts, components, and related items. By focusing on used and refurbished products, LKQ was able to undercut the pricing maintained by OEMs and the distributors related to them, at least that was the original strategy in the U.S.
The company has grown the business from about $300 million in the early 2000s towards the $10 billion mark in 2017. Following the 2011 purchase of Euro Car Parts and the 2013 purchase of Sator, and some other European deals, the company has built up a substantial European business as well. Dealmaking and organic growth only resulted in relatively modest dilution over time.
To further expand the business, the company announced a EUR1.5 billion deal to acquire Stahlgruber Otto to expand its aftermarket spare parts business in many Central European countries, in a deal set to add EUR1.6 billion in revenues.
Following the deal, net debt would jump to more than $4 billion, translating into a high leverage ratio of 3.4 times. With adjusted earnings trending at $1.90 per share, pre the Stahlgruber deal, I pegged earnings power at around $2 per share. The resulting 20 times earnings multiple and high leverage was a bit full given the signs of the times.
This looked reasonable given the strong (dealmaking) track record of the business, yet perhaps the valuation was full as well given the lower valuation of the market at large at the time, leverage employed, and some headwinds to the long-term outlook for the market segment.
Not Too Impressive
The share price run seen in 2017 marked a temporary peak. Shares actually fell back to the mid-twenties by 2019, marking quite a bit of reversal from the valuation in 2017. Following an obvious pullback in 2020, shares recovered to the $60 mark in early 2022 and now trade at $58 per share, near their all-time highs.
If we fast-forward to February 2022, we see that the business has grown sales more than 12% to $13.1 billion, which in a sense is not too impressive given the pro forma revenue number of $11.7 billion in 2018. What changed is that the business has become a lot more profitable, as adjusted earnings per share were reported at $3.96 per share, essentially double the earnings power back in 2017.
This was in part the result of operating margins having recovered to 11% and change as well as some more recent share buybacks, as net debt of $2.5 billion was quite reasonable, equal to just 1.4 times EBITDA. That was pretty much the good news as the company guided for modest growth in 2022, although the midpoint of the adjusted earnings guidance was actually seen down a bit to $3.87 per share.
In March of last year, the company actually announced a small divestment, selling its $400 million PGW Auto Glass business in Europe. For the remainder, it was pretty much smooth sailing, although far from an impressive performance, with results being largely stable. Absence of major M&A opportunities, the company announced a 10% hike in its dividend in October, now paying out $1.10 per share on an annual basis. Moreover, the company added another billion to its share buyback authorization, now standing at $3.5 billion.
For the year, the company posted a 2% fall in reported sales to $12.8 billion, the result of the divestment announced early in 2021 in Europe as well as adverse currency moves. Adjusted for a reported gain on that deal, operating margins were flattish around 11%, as adjusted earnings per share were flattish at $3.85 per share, down a bit, with net debt flattish at $2.4 billion. For 2023, the company sees a 6-8% increase in organic sales growth, with adjusted earnings per share seen up to a midpoint of $4.05 per share.
A Big (Potential) Deal
Just after the release of the full year results, LKQ Corporation announced a big deal again. The company has reached a deal to acquire Canadian-based Uni-Select to acquire this listed business for CAD $48 per share, in a deal valued at $2.1 billion.
With 269 million shares outstanding, LKQ currently commands a $15.6 billion equity valuation, or $18 billion enterprise valuation. As a result, this deal is worth more than 10% of LKQ here, making it a substantial transaction.
Uni-Select distributes automotive refinish and industrial coatings throughout North America as well as the UK. The deal is set to add $1.7 billion in sales, as the 1.2 times sales multiple comes in cheaper compared to LKQ´s own valuation at 1.4 times. Part of the discount comes as Uni-Select posts EBITDA margins around 8%, much lower compared to LKQ, albeit that $55 million in synergies are expected in connection to the deal.
Overall, the deal looks quite fair, and not a game changer in any specific way as pro forma leverage of 2.4 times looks reasonable.
And Now?
With LKQ Corporation trading at $58, and with earnings power seen around $4 per share, the resulting 14-15 times earnings multiple is quite reasonable. Leverage will increase a bit following the latest deal, as the question is what the company is gaining with this, as some questions can be raised on the strategic rationale behind the deal.
Nonetheless, LKQ Corporation valuations are reasonable, leverage is controllable, yet this is all reflected in the shares, which continue to trade near the highs. At these levels, I see about fair to attractive value here, although that I fail to have great conviction to add a position in LKQ Corporation here.
For further details see:
LKQ Corporation: On The Dealmaking Hunt Again