LKQ Corporation ($LKQ) Deep Dive
LKQ Corporation ($LKQ) Deep Dive
In the past "Like Kind and Quality." Moving forward “Leadership. Know-how. Quality.”
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What’s inside…
Disclaimer is at the end.
1. Company (elevator pitch)
Company that we will discuss today is LKQ Corporation. LKQ 0.00 is leading provider of (mostly aftermarket) auto parts (loosely said) that went from being M&A junky to (just recently) free cash flow spitting machine while still having bright future ahead.
2. What Attracted Me To LKQ?
What attracted me to LKQ is their clear vision to transition from being (pre 2019) M&A junky to (post 2019) FCF generator and disciplined capital allocator with the new potential growth segment (Europe).
3. History
In 1998 Donald Flynn founded LKQ Corporation with the goal to provide quality auto parts to a fragmented industry. LKQ Corporation formed with first 3 acquisitions: Triplett Auto Recyclers, Damron Auto Parts and Star Auto Parts.
LKQ subsequently expanded globally through internal development and approximately 270+ acquisitions of aftermarket, recycled, refurbished, and remanufactured product suppliers and manufacturers, self-service retail businesses, and specialty vehicle aftermarket equipment and accessories suppliers. For full timeline of acquisitions click here.
Notable acquisitions are:
Keystone Automotive
ATK High Performance Engines
Auto Data Labels
Stahlgruber
Elitek Vehicle Services
“From 1998 to 2018, the Company focused on consolidating the alternative and specialty vehicle parts markets to develop scale across an extensive network of salvage and aftermarket facilities throughout North America and on building a pan-European aftermarket parts distributor in the large, fragmented European market.”
4. Present
“Beginning in 2019, we reduced our focus on growth through acquisitions and increased our focus on organic growth. Moreover, we emphasized operational excellence, driving structural margin improvements across the business to fund investments to further extend our leading positions and capabilities and grow our market share.”
Currently, LKQ is headquartered in Chicago, Illinois. LKQ has 45,000+ Employees, 1,600 Locations (70+ salvage yards), and operated in 25 Countries.
As of 2022, Dominick Zarcone is President and Chief Executive Officer of LKQ.
LKQ has three business segments: North America & Self Service, Europe and Specialty.
North America & Self Service
North America segment is composed of wholesale operations, which consists of aftermarket and salvage operations, and self service retail operations.
LKQ’s wholesale operations in North America sell five product types (aftermarket, OEM (Original Equipment Manufacturer) recycled, OEM remanufactured, OEM refurbished and, to a lesser extent, new OEM parts) to professional collision and mechanical vehicle repair businesses, which represents the source of the majority of the revenue generated by the segment.
Additionally, LKQ is growing it’s diagnostics and repair services business.
LKQ’s self service retail operations, most of which operate under the name “LKQ Pick Your Part,” allow consumers to come directly to the yard (70+ yards) to pick parts off of salvage vehicles. In addition to revenue from the sale of parts, core, scrap steel and other metals, we charge a nominal admission fee to access the property.
Europe
LKQ Europe also known as 1 LKQ Europe, with its head office in Zug, Switzerland, is the leading distributor of automotive aftermarket parts for cars, commercial vans and industrial vehicles in Europe.
LKQ’s Europe segment operates in over 20 countries and was built on four key acquisitions: Euro Car Part (2011), Sator/Fource (2013), RHIAG Group (2016) and STAHLGRUBER Group (2018) as well as recycling specialist, Atracco.
European strategy, facilitated through 1 LKQ Europe program, is to leverage the strengths of acquired businesses, reduce procurement costs by consolidating and streamlining our product offerings, and combine into an integrated organization driving for functional excellence with the necessary technology linking our business processes with our customers and suppliers. As part of our 1 LKQ Europe program, we are integrating our European operations as we optimize purchasing, warehousing, systems, logistics and back-office functions, and align our private label products across the segment. We are reorganizing our non-customer-facing teams and support systems through various projects including the implementation of a common ERP platform, rationalization of our product portfolio, and creation of a Europe headquarters office and central back office.
Short version - Put the whole Europe segment under one roof and synergize it to the max.
LKQ also holds a minority interest in Mekonomen Group.
1 LKQ Europe is still work in progress and is a potential source of both inorganic and organic growth in Europe. Although given the current macro environment in Europe and war in Ukraine, it might take “a bit longer”.
Specialty
LKQ is the leading distributor and marketer of Specialty automotive equipment and accessories (which was formed in 2014 with acquisition of Keystone Specialty) in North America, serving needs of auto enthusiasts and their installers across the US and Canada.
Specialty product offerings include: RV, truck & off-road, towing, speed & performance, wheels, tires and performance handling as well as miscellaneous accessories.
LKQ’s Specialty segment offers the most comprehensive selection of specialty automotive equipment in the industry, with 800+ suppliers, 185,000 unique stocking SKUs and over 300 million dollars in inventory strategically located in 7 warehouses across the continental US.
Interesting chart on how “LKQ Vehicle Dismantling Process” works:
5. Management
LKQ is a large company with many people working for it, but there are a few individuals that are worth point out in management roles:
Dominick Zarcone - President and Chief Executive Officer
Dominick Zarcone became LKQ’s President and CEO in June 2017. Mr. Zarcone was Executive Vice President and Chief Financial Officer of LKQ from March 2015 to May 2017. Prior to joining LKQ, Mr Zarcone held few different roles all around Investment Banking.
Varun Laroyia - Chief Executive Officer and Managing Director of LKQ Europe
Varun Laroyia became LKQ’s CEO and Managing Director of LKQ Europe in September 2022. Mr. Laroyia was LKQ’s Executive Vice President and Chief Financial Officer from October 2017 to September 2022. Prior to joining LKQ, he was the CFO of CBRE’s Global Workplace Solutions (GWS) business since 2015, following CBRE’s acquisition of the GWS business from Johnson Controls Inc. (“JCI”), where he was the CFO and Vice President of Information Technology since 2013.
Rick Galloway - Senior Vice President and Chief Financial Officer
Rick Galloway became LKQ’s Senior Vice President and CFO in September 2022. Mr. Galloway was LKQ’ CFO of LKQ Wholesale - North America and Self Service segments from July 2019 to September 2022. Prior to joining LKQ, Mr. Galloway held various positions at Alcoa Corporation from 2010 to 2019, including CFO of Alcoa’s Engineered Products and Solutions division, a business that consisted of 97 manufacturing facilities across the globe.
Michael Clark - Vice President - Finance & Controller
Michael S. Clark has been LKQ’s Vice President - Finance and Controller since February 2011. Prior thereto, he served as Assistant Controller since May 2008.
Highlights from LKQ’s Board of Directors:
Joseph Holsten - Extensive knowledge of LKQ business and recycling industry.
Patrick Berard - Variety of leadership positions in European distribution businesses.
Meg Divitto - Expertise in IoT, digital strategy, and automotive technology.
Robert Hanser - Extensive European automotive aftermarket experience.
Blythe McGarvie - CPA with experience in European operations.
John Mendel - Knowledge of automotive industry.
Jody Miller - Diverse technology, automotive, and Board experience.
Xavier Urbain - Significant global supply chain and logistics experience.
Many members of LKQ have been with LKQ for a long time and been brought up in ranks within the company promotions while current CEO Dominick Zarcone is an “outsider” having background in capital markets and wealth management.
I believe with Mr Zarcone’s help looking at the business from different “set of eyes”, LKQ will be able to execute on what company is currently promising (and already delivering).
Although no single insider owns large amount of LKQ shares, I do think management is working for the shareholders (and stakeholders) and in the long run this could be a potential “hidden” competitive advantage that you cannot screen for.
All together insiders own <1% of the outstanding shares of LKQ.
There has been some (new) implementation with management toward all employees, where employees are being educated and encouraged in contributing to their 401K plus (albeit minor) stock-based compensation to promote “ownership”. Since LKQ is a multi-billion-dollar company “little amount” of shares from regular employees does not add up to being a lot, but if done properly and for a long period of time, I think can become a good way to educate everyone in thinking of themselves as being part-owners of LKQ.
6. Competitors
This was taken from LKQ’s 2021 10-K:
We face competition from local, national, international, and internet-based vehicle products providers, and this competition could negatively affect our business.
In the U.S. and Europe, local companies have formed cooperative efforts in an attempt to more efficiently compete against us in all aspects of our business.
Although it’s true that LKQ faces competition from all angles, the “danger degree” of competition is not really the real problem and in reality LKQ is the largest fish in a pond.
It was shown/proven during pandemic, LKQ was able to take share and flex their muscle during shortage of supplies with their logistics and size. Providing needed parts to whomever needed while competitors struggling due to shortage.
As said before mostly LKQ’s competitors are small shops but you could also (to some extend) throw in companies like Genuine Parts Company (but not really) or any other big aftermarket parts seller.
7. Financials/Metrics
As of December 18th, LKQ’s Market Cap is $14.06B.
LKQ is trading at P/E of 12.5, Price/Sales of 1.1, and EV/EBIT of 12.5.
Total Revenue is $13B and Net Income is $1.1B.
Cash & Equivalents is $269M and Total Debt is $3.6B.
Gross Profits/Margin and Free Cash Flow have been on the rise since 2016ish:
Debt and Shares Outstanding have been on decline since 2020:
What really matter to me:
ROIC is almost 15% (I like to see 15%+)
ROE is around 21% (I like to see 15%+)
Gross Margins are around 40% (I like to see 50%+)
Free Cash Flow Yield is almost 5% (I like to see 5%+)
PEG is around .40 (I like to see below 1)
Debt is around $3B and FCF is around $1B (although I would like to see no Debt or as close to zero as possible, I feel comfortable that management will be able to (gradually) pay down debt as they have been doing since 2020)
Moody’s, Fitch, and S&P rated LKQ as Baa3, BBB-, and BBB- with stable outlook.
8. Thesis
Bull Case
Durable Moat (Economies of Scale)
LKQ has what I believe a durable moat. LKQ’s size/stability compare to most other players in the same field (both in USA and Europe, but much more in USA), gives LKQ advantage in providing better, quicker, and more liability services/parts.
This can easily be seen during the 2020 with lockdowns and ship/supply shortage (for others) while LKQ was able to get most of the necessary parts in advance via ships/logistics and not experience the same problems as all/most of LKQ’s competitors.
Execution
Management has laid out their plan for the near future which is: paying down debt, buying back shares, paying out dividends, and focusing more on their employees while taking market share from smaller player plus developing Europe
All should directly and indirectly benefit LKQ’s stock price in the long run.
Europe
Although taken slower pace then management would like, LKQ is (slowly) taking market share in most of the EU countries (in some places more and in others less) and that is what really matters.
With Varun Laroyia becoming Chief Executive Officer and Managing Director of LKQ Europe in September 2022, moving forward will be interesting to see what LKQ can do in Europe.
Just a reminder Varun Laroyia was LKQ’s Executive Vice President and Chief Financial Officer from October 2017 to September 2022.
State Farm
In 2022 the nation’s largest auto insurer started a pilot program called the “2022 Non-OEM Parts Expansion Test” and (assuming everything went well) State Farm has extended the pilot to beginning or middle of 2023.
Backdrop, State Farm had suspended the specification of aftermarket parts in 1999, after two Illinois courts found that State Farm had deceived policyholders by specifying the use of non-OEM parts for collision repairs and breached its contract with the plaintiffs.
Using AI and Technology
I don’t know how much of it really is a “bull case” but I do want to point out that LKQ is leaning in into AI when bidding for vehicles to get the cheapest, the best, and quickest/largest amount of vehicles with the help of AI when scanning pictures of the “smashed cars” at the action (AI can be trained to do a much better job and much quicker at it than any amount of humans… something that not everyone will be able to afford to do aka small shops that are competing with LKQ) and using automation in the facilities to speed up process and help human workers plus to minimize the accidents on the job.
Kill Switch
Valuation
If for whatever reason valuations would go out of this world (with no validation), I would have to consider to sell out of LKQ.
(Something like what happened to IRBT 0.00 in January of 2021.)
China/Taiwan
If China was to invade Taiwan, I would have to consider selling out of LKQ. There is just too many parts that are being shipped out of Taiwan that LKQ’s execution will most likely be drastically affected.
Collision Avoidance Systems & Autonomous Driving
If Autonomous driving will ever become a reality (which means there would be little to no car accidents, assuming of course) I would have to consider selling out of LKQ. Although I must say, cars would still have to get fixed for many different reasons (at minimum regular wear and tear) so this really depends how LKQ would evolve…
Shift In Management’s Vision
If managements start to deviate from Execution, I will have to consider selling out of LKQ. This type of business needs clear and simple/harmonic vision to be successful.
9. Personal Touch
Does This Company Meets The Check List Requirements?
Yes, it does.
Is this a WONDERFUL Business or a GOOD Business?
This is a GOOD Business that is turning into WONDERFUL.
Guru Holdings?
Currently none of the gurus that I follow own any significant amount of LKQ 0.00 shares.
Margin of Safety Price?
Margin of Safety is ranging from about $30 to $45.
Fair Value? Price Target?
Based on my model, Fair Value range is $60 to $80.
Price Target is $65* (or about $17B).
assuming no growth.*
Evaluate quarterly/yearly from there on as I think this could be a sleepy compounder.
Holding Period?
As long as management is executing on their vision of paying down debt, repurchasing shares, paying out/increasing dividends, and expending into Europe + taking market share in US , I’m happy to be a shareholder.
10. Conclusion
In conclusion, LKQ is a good company that is one its way to become great with management that understands its fiduciary responsibilities towards shareholders and stakeholders (which is uncommon and very important).
I believe that LKQ is currently transitioning into the next chapter of growth/evolution and stock market is not fully appreciating everything that management is doing with the company.
Given current macroeconomic uncertainty, I believe LKQ has what it takes to weather out the bad environment (inflation, war in Ukraine, China/Taiwan, hiccups in Europe) and come out of all of it as better/leaner/stronger company and in much better condition then it’s competitors. Even with no growth but with less competition, LKQ would be able to “take bigger” bite out of the pie which would mean bigger profits.
Holdings Disclosure
At the time of this publication, I do own shares of LKQ 0.00 .
Disclaimer
The information in this article is provided for informational and educational purposes only.
The information is not intended to be and does not constitute financial advice or any other advice, is general in nature, and is not specific to you. Before using this article’s information to make an investment decision, you should seek the advice of a qualified and registered securities professional and undertake your own due diligence.
None of the information in this article is intended as investment advice, as an offer or solicitation of an offer to buy or sell, or as a recommendation, endorsement, or sponsorship of any security, company, or fund. The author is not responsible for any investment decision made by you. You are responsible for your own investment research and investment decisions.
I wonder if they would benefit from stagflation / auto supply chain issues (people repairing and running vehicles longer)