LKQ Corporation: Making the Most of Accidents

Sep.26.07 | About: LKQ Corporation (LKQ)

LKQ Corp (LKQX) makes most of its money by accident… car accidents that is. The company’s primary business is supplying used or refurbished car parts to repair facilities across the country. While it competes against a myriad of small junkyards, the company has built a diversified and expanding inventory of parts that allow it to fulfill requests for specific parts at nearly double the industry rate. This reliability factor makes the company the primary supplier for many large insurance companies who are able to save money by using refurbished parts instead of OEM equipment.

Although the company has attractive organic growth, much of its strength has come from management’s skillful acquisition strategy. Since coming public in 2003, the company has made over 30 acquisitions which has allowed it to expand its available parts inventory as well as invest in warehousing and distribution channels. Currently, LKQ is in the process of acquiring Keystone Automotive (NYSE:KEYS) for $811m which would be its largest acquisition to date. While both LKQ and KEYS shareholders must vote to approve the deal, it looks likely that it will be completed. Management has guided savings of $25-35m as the company is integrated over the next 2-3 years, and analysts have viewed this number as conservative. Baird expects savings to be closer to $35-40m. There are roughly 25 warehouses owned by LKQ within 80 miles of warehouses owned by KEYS which could likely be consolidated.

One of the largest opportunities for the company revolves around the State Farm insurance company. Currently, State Farm does not purchase aftermarket parts for its repair jobs. This is primarily due to a lawsuit they are involved with disputing the quality of repair jobs done years ago. Recently there was a ruling in favor of State Farm which could open the door for them to begin saving money by using aftermarket parts again. This could easily result in $300-$400m in annual revenue for LKQ which could translate into a 15% or more increase in sales.

LKQ not only sells used parts, but also participates in generic parts made by non-OEM manufacturers. This business is similar to the generic drug business in that the parts are new and fit manufacturers specs while often costing less than manufacturers such as Ford (NYSE:F) or GM (NYSE:GM) might charge. Currently, generic parts account for about 20% of LKQ’s sales but if the KEYS acquisition goes through, it would likely bump this portion of business to half of revenue. Since right now only 18% of collision repairs are done with used parts, diversifying into new generic parts would appear to be a wise strategy for LKQ.

Finally, when looking at the economic backdrop in US markets, there is some concern of a slowdown or recession. That scenario would not likely affect LKQ’s business as accidents will still happen on the road, and insurance companies will still be required to fix the damaged vehicles. There may be some positive effects on LKQ as insurance companies may have tighter budgets that would require them to use more used or generic parts in order to save on expenses.

So while LKQ would fit into the growth category (strong historical increases in both sales and EPS), it is also a very defensive play because of the market they operate in. The company just completed a secondary offering to raise cash for its KEYS purchase and it was well received by the market. I expect stable earnings growth over the next several years, and anticipate the stock continuing to trade higher based on fundamental strength.

Disclosure: Author has long position in LKQX