Author Topic: LKQ - LKQ Corp.  (Read 21928 times)

Ross812

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LKQ - LKQ Corp.
« on: March 04, 2013, 09:30:35 AM »
I’ve been trading around with UPS after selling the majority of my position. It was sold because I cannot hold something at a P/E of 20 that I can only see growing at 10%. I’ve been searching for a recession resilient (a company that is nimble enough to scale down or even profit from a deep recession) company with many of the same characteristics of UPS but with a higher growth rate. The UPS like qualities I am searching for are recession resilience, value to customer, the ability to pass inflationary costs on to customers, and in an industry out of the minds of our legislatively brilliant government. I had been watching Express Scripts (ESRX) for awhile and almost bought it after it dropped in the 4th quarter, but I think the PBM business might come under regulatory scrutiny as the government gets more and more involved with healthcare. Plan got me interested in Fiat which I consider a turnaround, but I started researching auto parts manufacturers and happened on LKQ Corp (LKQ).   

Overview:

LKQ provides is a vertically integrated provider of everything needed to repair a wrecked vehicle. The company operates in North and Central America as well as the UK.  Essentially the company buys totaled cars and salvages the usable parts to be resold through their distribution network to auto body repair shops, mechanics, car dealerships, and their own retail locations (Pick a Part). The unusable part of the car is then recycled. The company recently started to vertically integrate auto recycling by buying a shredder in Florida. In addition, the company imports aftermarket parts from Taiwan and China to provide customers with new as well as used alternatives when repairing vehicles. The company was founded in 1998 in Chicago, and was taken public in 2003.
   
What makes this business special?

LKQ operates in a highly fragmented market. Most salvaged automotive (alternative parts) parts operate on a small scale and only service repair shops in their immediate area. LKQ’s largest alternative parts competitor operates three distribution centers; in comparison, LKQ operates 24 regional hubs (equal to these distribution centers) 3 national distribution centers, and 94 retail locations. Their competitors can only provide limited service to their customers because of their scale. For instance, if a Honda Civic is in the body shop and needs alternative parts, the local supplier may only have two or three salvaged civics to choose from which means most repairs have to be accomplished with expensive OEM parts. LKQ operates on a national scale which means parts from cars salvaged after hurricane Sandy may end up in auto repair shops in Arizona. Bolt on acquisitions of fragmented local suppliers suddenly can market their parts nationally thereby increasing sales. This company gets better with size, i.e. the network effect.
LKQ’s network and size allows them to acquire salvage vehicles from auctions more efficiently than their competitors. An inventory of every part salvaged is recorded in their software system, along with demand for the part, and the negotiated price the part. Their software system takes this information and establishes a maximum bid for buyers at auction in real time. In other words, the company knows how much the totaled car is worth before they buy it. The car auctions are regional, and the company can avoid paying high prices for wrecked cars if there is cheaper inventory available elsewhere.

The company is very efficient. Totaled cars 1-7 years old bought at auction are processed for alternative parts then recycled. The company owns a precious metals recycler to recover platinum. Recovered gasoline is reused in the company’s heavy trucks to transport salvaged cars from auction to processing centers. Recovered oil is burned to generate heat and electricity in their national distribution centers, the remaining oil is sold to oil recyclers. Scrap metal is recovered and sold using the company’s newly acquired shredder in Florida or by third party contract shredders. Older cars (7+ years) or cars designated as crush only are placed on their 62 retail Pick-your-Part yards for 30-75 days to sell any usable parts before they are shredded and recycled. Pick-your-part is superior to local junk yards because of their constantly revolving inventory. Many junk yards have turnover times in years.

The company provides a one stop shop to auto repair and body shops. Not only do they have alternative parts available for sale, but also stock aftermarket parts available at a discount to OEM prices. If an auto body shop calls their regional hub and asks for a list of parts, the list is filled with alternative and aftermarket parts which are shipped to the body shop the following day. This saves the body shop from making several calls to multiple alternative parts suppliers and aftermarket wholesalers. LKQ developed a software system called keyless which is provided to auto body shops to help them better estimate repair costs based on the availability of alternative and aftermarket parts. This saves customers, often insurance companies, money (20-50% lower than OEM parts) and integrates the relationship between body shops and LKQ.

The company has relationships with insurance companies who often first require the use of alternative parts over OEM parts. LKQ is designated as the preferred supplier of alternative parts for several insurance companies in North America. LKQ actively seeks third party certification and testing of their parts. Alternative and aftermarket parts from LKQ are warranted for the life of the vehicle and certified to be to identical or superior to OEM parts. 

What are the growth prospects?

The company has grown 20%+ annually for the last five years through organic growth and acquisitions. Organic growth is expected at 7-8%. OEM’s still provide over 50% of parts in the U.S. and 90% in the U.K. There is room for more uptake in substantially cheaper alternative parts. Costs can be cut by further vertical integration especially in third party recycling; the purchase of a shredder in Florida is the beginning of this integration. The alternative parts market is still highly fragmented and acquisitions of inefficient local operators add to the LKQ network. This is where the majority of their growth is going to come from. Substantial opportunities exist in Europe, where alternative parts use is less than 10%; LQK is now in the U.K with one distribution center, nine hubs, and 130 branch locations. This is not your typical value stock, I would view it as a good growth company at a reasonable price. 

Where’s the moat?

New facilities are difficult to open because of environmental regulations, permitting issues, and zoning. No one wants a junk yard, shredder, or potential brown field in their backyard. The national distribution networks, proprietary software provided to body shops, and relationships with insurance companies are difficult to replicate. The economics of the business makes bigger better. Smaller companies may be able to compete on price but not on product availability. This company operates independently to the financial markets. Individuals still drive and get into auto accidents (albeit somewhat less during recession) despite what the financial markets are doing. Junk yards and their parts business see an up-tick when car sales go down due to repair of older vehicles. This should be viewed as a recession resistant company.

What are the risks?

Well once again the government rears its ugly head. There was a law passed in the last ten years that requires a system to be developed to track vehicle VIN numbers and parts from those vehicles to verify they were not stolen. This would not sink the business model but would require another step when recycling vehicles. Any stolen vehicles would likely need to be turned over to the government. There was a court case against State Farm in Illinois in 2009 which concluded State Farm was not allowed to use non-OEM parts to repair vehicles because the vehicle has to be repaired to its pre accident state. State Farm lost. The decision was raised to the Illinois Supreme Court which overturned the ruling stating State Farm fulfilled their contractual agreement using alternative parts. The case was elevated to the U.S. Supreme Court which refused to hear it. Though the court case was overturned, some insurance companies now require OEM parts to be used in the wake of the trial. These companies may or may not come to once again allow non OEM parts.

OEM manufacturers have sued aftermarket parts manufacturers for patent infringement. There is currently a settlement with OEM manufacturers in effect until 2015 when it will be renegotiated. This concerns aftermarket parts and not alternative parts, but any change in this market could affect part of LKQ’s business. OEMs could also become more price competitive with alternative and aftermarket parts manufacturers. I view this as one of the primary risks to LKQ’s business model. Alternative parts are likely safe because of their substantial discount to OEM parts.
Environmental regulations could change and adversely affect LKQ’s business model. Brownfield cleanup costs make closing junk yards difficult, and increased regulations could cause unanticipated capital expenditures. LKQ already has reserves for environmental costs and holds excess reserves for unanticipated environmental cleanup, but costs above their reserve amount are possible if regulations change.

Price?

Like I said before, this is not your typical distressed asset value investment. We are trying to buy future cash flows at a discount. Using a DCF valuation of LKQ with a 5 year growth rate of 15% (analysts say 18.5% and past 5 years has been 26%, the company says this year will be 15%- 25% and that 2013 is projected a tough year due to cash for clunkers and a warm winter) and a terminal growth rate of 6% (below organic growth rate and low considering their prospects in both the U.S. and Europe) and a discount rate of 11% (8% + 3% inflation) I come to a DCF valuation of $26.87. The current price of $20.50 is a 25% discount to this conservative DCF. My more likely DCF is a growth rate of 16% for the next 10 years with a 6% terminal growth rate and 11% DR; the valuation comes to $39.83, meaning the margin of safety is almost 50%.

I am starting to slowly buy into LKQ. I think this company has a very deep moat that will widen with time. The company has to execute to attain its projected growth, but has proven the ability to do so in the last 10 years. The U.K. and the rest of Europe show a lot of promise going forward. A quick check of Dataroma shows that William Von Mueffling of Cantillon Capital Management started a 3.5% position in Q4 2012 at $18.50 to $23.00. Also directors bought May, June and September of last year at prices $17-$19. LKQ is also the Meridian Value Fund’s largest holding. Tell me what you all think. I am sure I missed some details, and I would like some weigh in on compensation and growth prospects. Thank you for any future help!
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Ross812

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Re: LKQ - LKQ Corp.
« Reply #1 on: March 04, 2013, 02:08:59 PM »
Here are some graphs to show how consistently the company performs. Notice how P/E and therefore share price was the parameter affected by the recession in 2008 and 2009:



Edit: I attached the picture below if the post is hard to see.
« Last Edit: March 04, 2013, 02:11:02 PM by Ross812 »
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constructive

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Re: LKQ - LKQ Corp.
« Reply #2 on: March 04, 2013, 03:37:38 PM »
They have a lot of intangibles on the balance sheet.  The charts for tangible book value, cash flow and free cash flow may not look quite as nice as book value and earnings.

Looks like a good company but doesn't strike me as really cheap.

Ross812

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Re: LKQ - LKQ Corp.
« Reply #3 on: March 05, 2013, 06:37:57 AM »
Here are the charts for tangible book value, operating cash flow, and free cash flow.  

 



 

Lets take a look at the intangibles on the balance sheet:

 

Quote

Intangible Assets:   2012            2011

Goodwill              1,690,284     1,476,063

Other Int Assets     106,715        108,910

        

Our goodwill would be considered impaired if the net book value of a reporting unit exceeded its estimated fair value. The fair value estimates are established using weightings of the results of a discounted cash flow methodology and a comparative market multiples approach. We believe that using two methods to determine fair value limits the chances of an unrepresentative valuation. As of December 31, 2012, we had a total of $1.7 billion in goodwill subject to future impairment tests. If we were required to recognize goodwill impairments, we would report those impairment losses as part of our operating results. We determined that no adjustments were necessary when we performed our annual impairment testing in the fourth quarter of 2012. A 10% decrease in the fair value estimates of the reporting units in the annual impairment test would not have changed this determination, and each of the reporting units had a substantial excess of fair value over carrying value.

 

The primary reason for our acquisitions made in 2012, 2011 and 2010 was to leverage our strategy of becoming a one-stop provider for alternative vehicle replacement products. These acquisitions enabled us to expand our market presence, widen our product offerings and enter new markets. When we identify potential acquisitions, we attempt to target companies with a leading market share, an experienced management team and workforce that provide a fit with our existing operations and strong cash flows. In many cases, acquiring companies with these characteristics can result in purchase prices that include a significant amount of goodwill.


 

The increase in intangible assets results from the purchase of new businesses at a premium to their net asset value. A good business should be worth more than its net tangible assets, and should be bought at a multiple of its cash flow. I agree that intangible assets 'goodwill' is high, but as an investor you can understand how this happens. How often can you acquire a great business with high cash flows completely unaffected by the last economic cycle for its tangible book value? 
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Ross812

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Re: LKQ - LKQ Corp.
« Reply #4 on: March 15, 2013, 11:13:03 AM »
From Morning* concerning the alternative parts market:

Quote
Use of alternative parts (recycled and aftermarket) has
steadily increased to account for 37% of all products used in
collision repairs compared with about 23% in 2000.
Alternative parts generally cost 20%-50% less than new
original equipment manufacturer, or OEM, products. The
recycled OEM product market (engines, transmissions, doors,
and so on) is composed of more than 6,000 companies, and
roughly 90% of those have less than $3 million of annual
revenue. In contrast, LKQ annual revenue is more than $3.0
billion, with about one third coming from recycled and
re-manufactured OEM parts. With a far larger capital base to
fuel growth, LKQ now owns around 450 facilities. An
integrated IT system allows each facility to stock the right
parts for customers. The result of this scale and integration is
that LKQ is out of stock far less than the 50%-60% industry
average.
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Ross812

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Re: LKQ - LKQ Corp.
« Reply #5 on: April 25, 2013, 08:25:46 AM »
Firing on all cylinders:

LKQ Corporation Announces Results for First Quarter 2013

-- Revenue growth of 16% to a record $1.20 billion

-- Organic revenue growth for parts and services of 9.6%

-- First quarter 2013 diluted EPS of $0.28

-- Increases 2013 organic revenue growth guidance

-- Agrees to acquire European parts distributor Sator Beheer

LKQ Corporation (Nasdaq:LKQ) today reported record revenue for the first quarter of 2013 of $1.20 billion, an increase of 15.9% as compared to $1.03 billion in the first quarter of 2012. Net income for the first quarter of 2013 was $84.6 million, an increase of 4.4% as compared to $81.0 million for the same period of 2012. Diluted earnings per share of $0.28 for the first quarter ended March 31, 2013 increased 3.7% from $0.27 for the first quarter of 2012. The Company noted that the first quarter 2013 diluted earnings per share included a loss equal to $0.01 per share resulting from restructuring and acquisition related expenses and the change in fair value of contingent consideration liabilities. Earnings per share in the first quarter of 2012 included a gain equal to $0.02 per share that resulted from a favorable legal settlement.

"I was particularly pleased with our results this quarter because, adjusting for the legal settlement in 2012 and other charges, diluted earnings per share grew by 16% compared to the prior year quarter. We also delivered strong organic revenue growth for parts and services of 9.6% despite the quarter having one less selling day in the US and two less selling days in the UK," stated Robert L. Wagman, President and Chief Executive Officer of LKQ Corporation. "I am also proud of our ability to deliver bottom line growth, with the first quarter of 2013 producing record earnings."

Sator Beheer Acquisition

On April 23, 2013, the Company agreed to acquire Sator Beheer ("Sator"). Sator is the market leading distributor of automotive aftermarket parts in the Netherlands, Belgium, Luxembourg and Northern France. Headquartered in Schiedam, the Netherlands, Sator is the parent company of eight operating subsidiaries. The group has over 800 employees serving a diverse base of more than 6,000 customers and offering a broad product line of over 150,000 SKUs from eleven distribution centers. In 2012, Sator reported revenue of EUR288.0 million and EBITDA of EUR24.0 million.

"This strategically significant acquisition further increases LKQ's European footprint and market share, and provides a platform for future growth on the continent. Sator should also complement our existing Euro Car Parts operations in the UK and allow for the realization of cost savings," added Mr. Wagman.

The purchase price is expected to be approximately EUR210.0 million and will be funded by drawing on the Company's revolving credit facility. The transaction is expected to close the first week of May 2013.

Balance Sheet and Liquidity

As of March 31, 2013, LKQ's balance sheet reflected cash and equivalents of $63.0 million, and obligations outstanding under the Company's credit facilities were $922.5 million ($415.0 million of term loans and $507.5 million of revolver borrowings). Total availability under the credit agreement at March 31, 2013 was $390.8 million.

After drawing the funds for the Sator acquisition, availability under our credit agreement will be approximately $115 million.

The Company is in discussions with certain of its lenders and other parties concerning changes to its existing credit facility, which changes, if agreed to by the lenders, would include, among other things, an increase in the amounts available under the revolving credit facility and term loan borrowings under the credit agreement. These discussions are still ongoing so there are no assurances that these discussions will be successful or that a definitive amendment will be executed, or that the credit facility will be increased or extended or as to the specific terms of any amendment.

Other Events

During the first quarter of 2013, the Company acquired a distributor of collision repair parts and products primarily for automotive climate control systems in the United Kingdom; a paint distribution business in Ontario, Canada; and an aftermarket radiator distributor in Florida.

Company Outlook

The Company increased its organic revenue growth guidance and reaffirmed its guidance on diluted earnings per share, operating cash flows and capital expenditures for 2013. The guidance does not include the effect of the pending acquisition of Sator, which is expected to be completed in the second quarter, or any possible changes to our credit agreement as described above.

                                             Updated Guidance                        Prior Guidance
Organic revenue growth             6.5% to 8.5%                             5.5% to 7.5%
Net income                          $305 million to $330 million          $305 million to $330 million
Diluted EPS                        $1.00 to $1.09                                $1.00 to $1.09
Operating CF                  Approximately $300 million               Approximately $300 million
Capital expenditures          $100 million to $115 million           $100 million to $115 million
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ItsAValueTrap

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Re: LKQ - LKQ Corp.
« Reply #6 on: April 25, 2013, 12:37:24 PM »
Thanks a lot for writing this company up.

It seems like their only competitive advantage is size/scale.  I don't understand the auto market well but sometimes being #1 in size really does give you a moat (e.g. like in semiconductor manufacturing).

The valuation is a little high for my tastes so I'm going to watch this from the sidelines.  Right now I'm really interested in ASPS as far as quality/growth businesses go.
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Ross812

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Re: LKQ - LKQ Corp.
« Reply #7 on: August 01, 2013, 11:14:38 AM »
Another quarter of strong growth.

Quote

  • Revenue Growth of 24% to a Record $1.25 billion
  • Organic Revenue Growth for Parts and Services of 13.1%
  • Second Quarter 2013 Diluted EPS of $0.25
  • Annual Guidance Updated
CHICAGO, Aug. 1, 2013 (GLOBE NEWSWIRE) -- LKQ Corporation (LKQ) today reported record revenue for the second quarter of 2013 of $1.25 billion, an increase of 24.4% as compared to $1.01 billion in the second quarter of 2012. Net income for the second quarter of 2013 was $76 million, an increase of 18.3% as compared to $64 million for the same period of 2012. Diluted earnings per share of $0.25 for the second quarter ended June 30, 2013 increased 19.0% from $0.21 for the second quarter of 2012. The Company noted that the second quarter of 2013 and 2012 diluted earnings per share included losses totaling $0.01 per share resulting from restructuring and acquisition related expenses, the change in fair value of contingent consideration liabilities, and, in 2013 only, a loss on debt extinguishment. Earnings per share in the second quarter of 2012 also included gains equal to $0.02 per share that resulted from favorable legal settlements.

 "Our very strong organic revenue growth of 13.1% for parts and services revenue was driven by improvements across both our segments. We were particularly pleased to see our North American operations report a robust 7.3% parts and services growth, while organic growth in our European operations accelerated to 37.8%," stated Robert L. Wagman, President and Chief Executive Officer of LKQ Corporation. "Our 24% revenue growth translated into growth in EPS of 30% (after adjusting for acquisition related items, our refinancing costs and favorable legal settlements last year) demonstrating the leverage we are achieving with our revenue growth," continued Mr. Wagman.

 On a six month year-to-date basis, revenue was $2.45 billion, an increase of 20.1% from $2.04 billion for the comparable period of 2012. Net income for the first six months of 2013 was $160 million, as compared to $145 million for the first half of 2012. Diluted earnings per share was $0.53 for the first six months of 2013, as compared to $0.48 for the comparable period of 2012.

 Total organic revenue growth on a six month year-to-date basis was 9.5%. Parts and services revenue grew organically by 11.3%. Acquisition revenue growth on a six month year-to-date basis was 11.0%.

Guidance Updated:



Up 11% today.
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Ross812

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Re: LKQ - LKQ Corp.
« Reply #8 on: January 15, 2014, 11:46:33 AM »
Short Report out on LKQ:

http://www.bloomberg.com/news/2014-01-15/lkq-drops-as-short-seller-prescience-says-growth-is-overstated.html?cmpid=yhoo

Down about 15%. It's available at:

http://www.presciencepoint.com/research/

So far I see they are attacking LKQ for a margin decline from 46% to 41% since 2005. This due to an increase in salvage vehicle prices, not some manipulated metric. There are a lot of "we believe" statements in this part of the report.

There is a chart and paragraphs connecting LKQ management to Waste Management fraud back in the 90's. This is something I need to look into further.

The accounting for inventories is something to definitely check into (page 79 and 80):

Quote
According to the ‘Salvage Auto Consultant’ interview on the previous slide, LKQ buys recycled auto distributors at a maximum of 60% of annual sales, a valuation that applies solely to the operation and excludes the value of real estate. Based on his experience, LKQ targets companies generating 10% profit margins. If we assume the purchase price ranges from 40-60% of sales, this would imply:
LKQ is paying 4x–6x net earnings for recycled auto parts distributors
Acquired inventory values make up 33% –67%of the purchase price
From 2003 to 2012 (excluding the impacts of the distressed purchase of Greenleaf), LKQ spent $2.3 billion on acquisitions. If we assume for conservatism that the purchase price allocations to PP&E were all related to real estate buys and back the cumulative PP&E allocation out from the cumulative purchase price, we are left with $2.1 billion spent to acquire the businesses. Over the same period $482m of the cumulative purchase price was allocated to inventory, or only 22.7%of the cumulative purchase price, ex PP&E.
We believe LKQ’s purchase price allocations are consistent with a policy of having used acquisition accounting to systematically understate acquisition inventory values, thereby, inflating its financials and successfully stabilizing its inventory turnover


Overall, the report does not have a lot of substance and puts a negative spin LKQ's business model. It paints a picture that the same management who orchestrated the Waste Management fraud are doing it again at LKQ. The report highlights a lot of goodwill adjustments made when LKQ acquires junk yards. The caveat to this is once LKQ acquires a yard, the yard's inventory becomes available on a national scale and inventory that is unused is recycled by LKQ instead of a 3rd party meaning the junk yards costs go down and customer base increases. I'm guessing management will respond to the short thesis sometime this week. At any rate, I added today at $27. 

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dwy000

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Re: LKQ - LKQ Corp.
« Reply #9 on: January 15, 2014, 12:29:20 PM »
Great write up Ross.  I've watched this one for a while too because I like the recession resistant aspect as well as the unique position from its scale.  I just struggle with the price!

The short report comment on inventory is an interesting one but given the company turns it's inventory up to 7x per year, the so-called bump in earnings they would get from lower COGS would only be a one time bump and only apply to one-seventh of the annual sales of that purchased company.  An issue, maybe but not something to justify shorting.

I'm curious, in your DCF analysis from your original write up you were using 15% annual growth.  What did you take out of free cash flow for acquisitions given organic growth is only about 6-8%?  How much would that move the needle on the overall DCF value?

Thanks