Big Uptick In Adesa's Salvage Units Likely Positive For LKQ Corp.

Includes: KAR, LKQ
by: Jerry Marks

On the other side of the auction market (from whole) are "salvage" units. When a bad driver slams into someone at 100 miles an hour and "totals" the vehicle, it is considered a "salvage" vehicle. Usually the vehicle gets sent to the junk yard, broken up into parts, and then used at body shops in fixing "salvageable" vehicles.

But what junk yard does the vehicle end up at? LKQ Corp. (stands for Like Kind Quality) (LKQX) is the only publicly traded company with salvage facilities. LKQ buys some of these wrecked vehicles directly from the insurance companies (that now lay claim to this "totaled" vehicle). But most of the time, the salvage yards (like LKQ), go to an auction to buy the vehicles they want so they can have the parts they need for the body shops. Adesa (NYSE:KAR) is one of those auction houses, and they are merging with one of the industry leaders (Insurance Auto Auctions) in the area of salvage vehicles.

In the fourth quarter of 2006, salvage units that went through Adesa's auctions were 71,000, up a startling 37% year over year. Now historically (in the fourth quarter), Adesa's salvage unit growth rates were: 13% (2005), negative 4% (2004), and 14% (2003). So this was a dramatic jump in the number of salvage units being sold at Adesa's auctions. Maybe it is simply due to Adesa's group beginning to learn better practices from Insurance Auto Auctions (one of the industry leaders). But it may also be a sign that the availability of (salvage) vehicles throughout the industry increased (maybe there were more accidents in the fourth quarter). Supply drives demand in this business.

Far too often a body shop calls a salvage facility and is unable to get a recycled part simply because the salvage facility does not have the part. So if Adesa is seeing such a dramatic rise in the number of salvage vehicles being sold at auction, it likely is a good sign that distributors like LKQ had more salvage parts to sell in the fourth quarter (in other words LKQ likely had strong same-store sales in the fourth quarter of 2006).

I don't like getting caught up in the quarters. And we really won't get a good idea whether or not Adesa's increase was industry or process improvement/market share driven until Copart (NASDAQ:CPRT) reports their quarterly results (likely in a month or two). But, Adesa's really strong showing on the salvage side does give an indication that things were pretty good in the salvage market (and thus for LKQ) in the fourth quarter.