Auto replacement parts business offers long-term growth potential

Dear Mr. Berko:

I’m a 42-year-old female professional administrator, and I invest for long-term growth. In 2011, I bought 200 shares of LKQ Corp., which sells auto and truck replacement parts, at $23, and a year later, it split 2-for-1. Now I have 400 shares of LKQ, worth about $13,700. But the price growth of the shares seems to be leveling off, and they can’t seem to get above $36. Do you think I should sell LKQ, take a profit and look for another growth stock?

— B.K., Akron, Ohio

 

Dear B.K.:

What is a professional administrator?

LKQ Corp. (LKQ-$34.21) was founded in 1998 and financed by Waste Management executive Donald Flynn, who left that company to run LKQ. In those days, the auto/truck replacement parts business was a disorganized, ragtag $8 billion industry, with 11,000 junkyards serving 200,000 collision repair shops, recycling 11 million junked cars each year. Most were family-owned businesses, and few had computer inventory systems. Many fit the stereotypical image, with menacing junkyard dogs and greasy shade-tree mechanics.

Flynn, seeking a fragmented industry to consolidate as his former employer had done hauling garbage, smartly settled on salvaged auto/truck parts. By late 1999, Flynn, with backing from Waste Management’s Wayne Huizenga and his AutoNation car retailer (LKQ’s first customer), had bought LKQ’s 35th salvage yard. By year’s end, with just 10 percent of the parts purchased by repair shops coming from salvage yards, LKQ had posted $195 million in revenues, served 35 of the top 50 markets and begun the process of setting up parts distribution centers all over the U.S. And in late 2003, with $490 million in revenues, underwriter Robert Baird took LKQ public at $13 a share. By 2007, LKQ was bringing in $1.1 billion in revenues, and earnings were 23 cents a share, though the stock was trading at an abysmal $7. Five years later, LKQ was trading at $40 and split 2-for-1. Since then, cash flow, revenues and earnings have increased each year by the low double digits. Resultantly, earnings of $1.85 share and cash flow of $2.60 are expected this year, made possible by 43,000 employees producing $9.4 billion in revenues. LKQ’s management is still on the acquisition trail, and the replacement business still has enormous growth potential in the U.S. and overseas.

Prospects for LKQ continue to be excellent. The company has a symbiotic relationship with many auto insurers. LKQ is the largest buyer of insurance company-auctioned salvaged cars and is the nation’s largest provider of collision repair and recycled and aftermarket auto/truck parts. This company has 571 salvage yards in the U.S., 91 yards in the U.K. and 81 in Scandinavia and the Netherlands. Higher new car prices and credit problems are encouraging buyers to repair and keep their cars longer. Americans and Europeans are driving at record mileage levels, and this elevated usage, supported by lower fuel costs, means more replacement parts will be used by consumers. The global salvage business continues to grow at a record pace, with record volume coming from China — China is the key driver for global auto demand — and solid revenue growth coming from Europe. On the negative side, the industry and LKQ face some challenges in South America, particularly Brazil and Argentina, plus unfavorable foreign exchange rates.

Management is doing a yeoman’s job of running this company, and many on Wall Street feel that LKQ shares could double in price within the coming four years. Net profit margins continue to improve. Return on capital and return on shareholders’ equity are impressive. And long-term debt should decline. So be patient and hold your shares. Thomson Reuters has a “buy” recommendation on LKQ, and so do Ned Davis Research, S&P Capital IQ, J.P. Morgan and Robert W. Baird. Meanwhile, Artisan Partners, Vanguard, State Street, BlackRock, MFS, American Funds and Bank of New York are major shareholders. However, I’m mindful that in the past dozen months, some officers and directors have sold several hundred thousand shares of LKQ for between $31 and $34 a share. And not a single officer or director purchased so much as 100 shares. But with potential earnings of $3 a share by 2022, LKQ could easily trade in the middle $60s.•

Please address your financial questions to Malcolm Berko, P.O. Box 8303, Largo, FL 33775 or email him at mjberko@yahoo.com.  The opinions expressed in this column are those of the author.

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