Learning About LKQ Corp (LKQX)

LKQ Corp (LKQX) sells replacement parts to repair cars and trucks, and operates in the U.S. and Canada.  With more than 325 facilities in North America, LKQX is the nation’s largest provider of aftermarket and recycled parts.

LKQX was the Online Stock Study at the BI website for May 2011.  It was led by Dan Rutter, a Director of the Puget Sound BI Chapter and a professional portfolio manager and research analyst. 

The recorded session and Dan’s handouts are available to BI members.  Sadly, the Consensus SSG is, once again, not available and I had to play (and replay) the recording to retrieve the SSG details.  [See footnote 1]

Company Background:

- LKQX operates in three segments: wholesale aftermarket and recycled products, self service retail products, and recycled heavy-duty truck products.  

** However, these segments are not reported seperately according to the company’s 2010 Annual Report.

- LKQX is a large operation: in 2010, its wholesale aftermarket and recycled parts unit carried more than 75,000 SKUs and purchased 198,000 vechicles;  self-service retail bought 297,000 vechicles, and its heavy-duty truck unit purchased 4,000 vechicles.

** Total Sales grew 20.6% in FY 2010 and EPS grew 30.7%.

 ** Organic growth in revenues was 6.6%.

** In 2010, Sales of vehicle replacement parts and services represented 86% of Total Sales.

** Sales and EPS grew 33% & 30% over the last 5 years and 13% & 27% over the last 3.

- Since its formation in 1998, the company has made over 100 acquisitions and is the only provider of aftermarket & recycled auto parts with a national presence.

** LKQX considers its geographic locations to be a competitive advantage and strives for next-day delivery.

** Keystone Automotive Industries, a key competitor and a leading distributor of aftermarket parts, was its most significant acquisition in October 2007.

- In 2010, LKQX paid $170.4M for 20 acuisitions: wholesale products (16); recycled heavy-duty truck products (1); self-service retail (2); and tire recycling (1).

- In the first two months of 2011, LKQX made 4 acquisitions: an engine remanufacturer; auto heating and coooling parts; wholesale recycled parts; recycled heavy-duty trucks. 

SSG Discussion:  

After this table, I discuss several key SSG judgments, LKQX’s competitors, its Pre-Tax Profit Margins and Return on Equity, and its Financial Condition. 

LKQ Corp (LKQX)	CONSENSUS & DAN SSG	ARMIN	TAKE STOCK	SEAN P from          BI’s First Cut
Date	4-13-11	4-15-11	Same	11-5-10
Data	Mstar via B I	Same	Mstar via SC	Mstar via SC
Price	$24.39	$23.61	$23.67	$22.59
52 week High &     Low Price	$26.30 & $17.29	Same &           Same	Not Used	$22.66 & $17.06
Last Quarter of     Reported Data	Q4 ending 12/32/10	Same	Same	Q3 ending 9/30/10
Software Used	TK 6	Same	TS Online	TK 6
Project Growth      From End of	Last Q	Last Q	Last FY	unknown
Sales Growth	16.00%	15.00%	12.50%	17.00%
EPS Growth	17.00%	15.00%	20.00% initial  10.40% final	17.00%
High PE	24.9                 (07-08 out)	21.5                  (06-08 out)	22.2               (07 Hi PE out)	27.4                 (07-08 out)
High EPS	$2.53	$2.31	$1.09	$1.96
High Price	$63.00           (26% > VL)	$49.70              (0.60% < VL) [See fn 2]	$41.91	$49.80
Value Line Estimated High Price =$35-50 as of 3-25-11
Low PE	14.4               (06 out)	13.6                  (06-08 out)	13.0               (06 Lo PE out)	14.0                  (03 & 06 out)
Low EPS	$1.25             (ttm)	$1.16                (ttm)	$1.15	$1.00          (ttm)
Low Price	$18.00            (low PE x        low EPS)	$15.80      (Same)	$14.95             (Same)	$14.00        (Same)
Upside/Down	6.1	3.3	2.2 (imputed)	3.2
Total Return	20.9%	16.1%	12.3%	17.1%
SSG Buy Under	Not Used	$24.28	$20.96	Not Used
RV/PRV	107.1/91.4  (07-08 out)	115.9/100.6 (06-08 out)	Not Used	97.1/83.3  (out: 07 High & 06 Low PEs)
RV/PRV                (no outliers)	90.1/76.9	87.6/76.0	Not Used
PTPM – 5 yr ave	09.80%            trend up	Same         Same	Same               trend N/A	9.50%, end 09 trend up
ROE – 5 yr ave    Ending Yr Equity	Not Used	10.30%            trend up	Not Used	N/A
ROE – 5 yr ave    Begin Yr Equity	12.70%          trend up	Same         Same	12.70%   trend N/A	12.7%, end 09 trend even
Debt to Equity –   5 yr ave	52.8%            trend down	52.9%               trend down	Not Used	45.3%, end 09 trend down

Estimating Sales Growth for the Next 5 years:

The Consensus/Dan SSG:

- Dan gave the participants 5 options to estimate LKQX’s future Sales Growth: 25.0%, Value Line’s 5 year historical growth rate; 22.5%, VL’s 3-5 year Revenue per Share estimate; 16.0%, the low-end of management’s suggested range; 15.0%, BI’s “safety” guidance; and 10.0%, an even more conservative estimate.

- The Consensus voted for 15.0%, BI’s “saftey guidance” [44% of the votes], but Dan inexplicably decided to use 16.0%, the low end of management’s guidance [40% of the votes].

- BI’s “safety” guidance is 20.0%, not 15.0%:

** “Don’t estimate sales and EPS growth above 20%.  That level of growth is difficult to sustain over a long period of time, particularly as a company gets larger.” [BI Stock Selection Handbook by Bonnie Biafore, 2003 edition, page 89]

- And, more appropriate than VL’s 25.0% historical growth is the reported history by Morningstar, the data source for our SSGs, which shows that LKQX’s 5 year historical sales growth was 33.4%, declining for the next three years to 12.9%, and rising last year to 20.6%.

Estimating EPS Growth for the Next 5 years:

The Consensus/Dan SSG:

- Dan gave the group 5 options: same as their Sales Growth estimate; 31.0%, LKQX’s 5 year historic growth; 27.0%, VL’s 3-5 year estimate; 21.0%, the company’s latest quarterly growth; 17.0%, slightly faster than its Sales Growth.

- LKQX’s latest quarterly EPS growth was 16.0%, not 21.0%.

- The Consensus chose the same as Sales Growth (15.0 or 16.0%), but Dan decided to use 17.0%, again inexplicably.

Armin’s SSG:

- When I did my SSG, the seven different long-term estimates I ALWAYS check averaged 18.40% with VL unusually high at 27.00% and FactSet CallStreet via CNNMoney low at 15.00%.

** The other five were all around 17.00%.

- I chose 15.00%, the lowest of the seven.  To learn what and which was low, it’s essential to check all seven estimates.

** If you’re interested in learning more about estimating EPS and how to get the seven different estimates, see Estimating EPS [click here].

Forecasting the High PE in the Next 5 years:

The Consensus/Dan SSG:

- Dan gave the group 5 choices: 30.6, five year average, unadjusted; 24.9, three year average after 2007 and 2008 are eliminated as outliers; 34.0, PEG of 2.0 with E at 17.0; 25.5, PEG of 1.5 with E at 17.0; None of the above.

- The Consensus chose 24.9, three year average after 2007 and 2008 are eliminated as outliers [61% of the votes] which Dan also chose.

Armin’s SSG:

- High PEs have been steadily trending down for the last 4 years from 43.1 in 2007 to 20.5 in 2010. 

- When I see such a downtrend, I typically use the latest year or an average of the last two.  Anything lower or higher seems like an uninformed and unsupported guess.

- I decided to use 21.5, the average of 2009 and 2010.

Final Results:

- The Consensus/Dan SSG began by estimating 17.00% future EPS for the next 5 years (Dan’s choice) and a 24.9 Projected High PE which resulted in a $63.00 Forecast High Price, some 26% greater than VL’s estimated $35-50 High Price.  It resulted in a 6.1 Upside/Downside Ratio and a 20.9% Total Return.

** 26% more than VL’s estimated High Price is too high for me.

- I estimated 15.00% future EPS and a 21.5 Projected High PE which resulted in a $49.70 Forecast High Price, just slightly less than VL’s estimate.  My SSG got a 3.3 U/D and a 16.1% TR.

- A minimum 3.0 U/D and a 15.0% TR are needed to satisfy the SSG Buy Criteria.  However, exceeding those criteria does not make for a better Buy.

Competitors:

- Morningstar lists Meritor (MTOR) [formerly Arvin Meritor] as a close competitor and YahooFinance lists Federal-Mogul (FDML) as a direct competitor.

- Morningstar, however, places MTOR and FDML in the Auto Parts Industry while it puts LKQX in the Industrial Distribution Industry.

- Dan thought LKQX’s closest competitor was U.S. Auto Parts Network (PRTS) which Morningstar places in the Specialty Retail Industry.

Pre-Tax Profit Margin (PTPM) and Return on Equity (ROE):

- Morningstar’s Industrial Distribution Industry has 32 companies including LKQX.  The industry average is 22.9% for PTPM and 53.4% for ROE, both of which are distorted by one or two atypical companes.

PTPM:

** One company, Shengkai Innovations, has a 5 yr PTPM average of 4056% that significantly distorts the industry average;

** Without Shengkai, LKQX’s 5 year average PTPM is slightly better than the adjusted industry average (9.80% vs 8.53%) and ranks 9^th out of 31.

** PRTS, in the Specialty Retail Industry, has a much worse 5 yr average PTPM than its industry (-3.1% vs 6.2%) and than LKQX (-3.1% vs 9.80%).

ROE:

** Two companies, Shengkai and Royce Resources have a 5 yr ROE average of 405.6% and 148.3% that distort the industry average;

** Without these two companies, LKQX’s average ROE is slightly worse than the adjusted industry average (10.30% vs 13.63%).

**PRTS also has a much worse 5 yr ROE average than its industry (-11.0% vs 18.5%) and than LKQX (-11.0% vs 10.30%)

- To learn more about investigating industry info, and how to identify and remove outliers that distort industry averages, see Investigating Industry Info [click here] .

Financial Condition:

- Value Line gave LKQX a B+ for Financial Strength, relatively low as that ranks 5^th on VL’s seven point scale.

- VL also reported that Long-Term Debt was $548.1M and that cash decreased 12%, to $95.7M from $108.9 one year earlier.

- The Annual Report spreadsheet by Bob Adams gave LKQX’s 2010 A.R. a 40 out of 100 with 7 Bullish Results and 12 Bearish:

** The Bullish good things included: sales increased, debt decreased, and interest coverage got a green flag as it was very good;

** The Bearish not-so-goods included: Free Cash Flow was low and got a red flag warning sign; LT Debt to Equity was high, may be excessive, and also got a red flag; Inventories and the Cost of Sales both increased and both were growing faster than Sales.

** Morningstar expressed no opinion about LKQX’s Financial Health, but did provide some facts: its Interest Coverage Ratio improved to 10.5x from a low of 5.3 in 2008 and it had $95.7 million in cash as of Dec. 31.

- Morningstar’s SSG Data reveals that LKQX’s Annual Debt to Equity was a whopping 88.5% in 2007, after it acquired Keystone Automotive, decreasing to 39.3% in 2010 for a 5 year average D/E of 52.8%.  The trend is down, but the metric is still high:

** LKQX’s Average Debt to Equity is greater than its adjusted Industry Average (38.9% vs 33.1%) after I eliminate four companies with Ave D/E over 100%.

 ** LKQX’s Debt to Total Capital is currently 30% which is high but not excessive as less than 35% is desired (varies by industry) according to “Classes to Go!: Company Debt” by Ann Cuneaz available to members at the BI website.

Conclusion:

 - LKQX easily satisfies the SSG Buy criteria, has a smart business plan, and has no challenging competitor, but I will not buy its stock:

** The 2010 Annual Report was way too difficult to read as it was overly wordy and unnecessarily vague;

** LKQX also took on way too much debt in 2007 (88.5% D/E) and I could never be sure if it would be so unwise again.

- Please let me know wha you think about LKQX and about my assessment.

Armin Fields

 [1] Sevral weeks after the Online Stock Study, BI uploaded a SSG to its First Cut page that purported to be the Consensus SSG, but was considerably different (e.g., Total Return = 20.9% vs 15.3% by the Consensus).

I decided to omit it because the differences were confusing and inexplicable.

[2] In an e-mail to me, Julie W pointed out that I had made a typo in my Forecast High Price which I have now corrected.

 

 

 

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