Pat McKeough recently replied to a member of his Inner Circle looking for an opinion on LKQ Corp. Revenue and earnings continue to jump for the auto parts distributor, says Pat, but there’s risk associated with that growth.
Q: Hi Pat and friends: I’m rebalancing my portfolio and would like to add another auto related stock (I already hold your recommendation Linamar). What is your opinion of LKQ Corp. listed on Nasdaq. Always appreciate your advice in the newsletters. Thanks.
A: LKQ CORP. (symbol LKQ on Nasdaq; www.lkqcorp.com) sells replacement parts for cars and light trucks in North America and Europe.
The company does not manufacture these parts. Instead, it buys wrecked vehicles at auctions and distributes reusable parts to collision repair shops. It also sells refurbished parts to consumers through over 100 company-owned retail outlets in the U.S.
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LKQ stands for “Like, Kind & Quality.” That’s a term for recycled or refurbished replacement parts that are acceptable to insurers in auto claims.
The company’s sales jumped 120.0%, from $3.3 billion in 2011 to $7.2 billion in 2015. Earnings gained 99.2%, from $219.2 million to $436.7 million; due to more shares outstanding, earnings per share rose 91.9%, from $0.74 to $1.42.
LKQ fuels its growth with acquisitions. In 2015, it spent $160.5 million buying 18 businesses.
Since the start of 2016, the company has completed two big acquisitions. It paid $602.0 million for Rhiag-Inter Auto Parts Italia S.p.A. This firm distributes aftermarket car parts in Italy and nine other European countries. LKQ also acquired Pittsburgh Glass Works, a leading maker of car windshields and windows, for $660.3 million.
Thanks to these purchases, LKQ’s sales in the three months ended March 31, 2016 rose 8.3%, to $1.9 billion from $1.8 billion a year earlier. Excluding the contribution of acquisitions, sales rose 4.1%.
If you exclude costs to integrate these businesses and other unusual items, earnings rose 10.2%, to $128.7 million, or $0.42 a share. A year earlier, it earned $116.8 million, or $0.38.
Growth Stocks: 2016 sales set to rise 6-8%
LKQ had to borrow the cash it needed to buy these new businesses. As a result, its long-term debt rose from $1.5 billion at the end of 2015 to $2.7 billion as of March 31, 2016. That’s still a manageable 27% of its market cap. It also held cash of $229.2 million, or $0.75 a share.
The company now expects its sales for all of 2016 will rise between 6.0% and 8.0%. Excluding unusual items, it should earn $1.76 to $1.86 a share for the year. The stock trades at 17.7 times the midpoint of that range.
Growth by acquisition adds risk. The company’s goodwill and intangible assets now total $3.5 billion, or a high 35% of the company’s market cap. That increases the risk of a big writedown if these new businesses fail to live up to expectations.
However, LKQ should continue to benefit as insurance providers encourage collision repair shops to use cheaper, recycled parts instead of new products. Refurbished parts now make up just 35% of this market, so there’s lots of room to grow. As well, low gas prices have prompted people to drive more. That should push up demand for replacement car parts.
Inner Circle recommendation: HOLD for aggressive investors only
For our advice on getting the most out of growth stocks, read 23 smart tips for investing in growth stocks.
For our recent report on a Canadian growth stock in the same business that we rate as a buy, read Aluminum car parts boost Linamar sales, earnings.
