We noticed a bullish thesis on LKQ Corporation (LKQ) on ValueInvestorsClub by goob392. VIC is our preferred site because the ideas there are generally posted by aspiring analysts who produce in-depth research. We find the ideas presented on the site well thought out and worth a read. Click here for the full article. Below we summarized the LKQ bullish thesis. LKQ shares were trading at $32 when this thesis was published.
Like Kind and Quality (LKQ Corporation) is a dominant American company with a 55% market share of the North American alternative auto collision parts distribution industry. LKQ is three times larger than its next largest industry competitor in Europe. With over 50,000 employee, the company has operations in North America, Europe and Taiwan. LKQ’s three business segments include North America (54% of 2019 EBITDA), Europe (34% of 2019 EBITDA), and Specialty (12% of 2019 EBITDA).
LKQ was recently changing tracks from multi-year M&A-induced growth to organic growth via integration and optimization, when COVID changed lives world over. The pandemic have slowed LKQ’s long-term execution plans to meaningfully improve profits, free cash flow, and return on capital. However, COVID has also led the company to seriously introspect on its cost and asset optimization opportunities. Severe drop in the miles driven in each of the company’s geographies during the pandemic has pushed the LKQ stock lower by 15% year-to-date as of 13 August, 2020.
Major Shareholder-Friendly Steps
In addition to shifting focus from leveraged acquisitions-based expansion to organic growth-based business optimization, LKQ has also changed the management compensation structure in early 2019. In stark contrast to the incentives in the past aligned with revenue, earnings and return-on-equity (debt-laden M&As) kind of metrics, they are now based on margins, FCF, organic growth, and return-on-invested-capital. Change of the top management at the European segment, including the appointment of new CEO with an extensive exposure in the European auto aftermarket, should also aid LKQ garner bigger market share and higher margins. LKQ’s efforts for asset optimization and performance hitherto are impressive.
An eventual normalcy in the miles driven and demand could lead the company to potentially generate a 10% free-cash-flow and earn about $3.25 in the fiscal 2022 (less than 10x P/E). The analyst, however, believes LKQ deserves a mid-teen P/E multiples, providing a potential 50+% upside in the stock price over the next year and a half for what can be categorized as highly defensive business. A moderate re-rating to 15x multiples would still be a discount to LKQ’s peers trading around 17-18x P/E. An aggressive re-rating of LKQ could bring its financial parameters in line with the peer group, and potentially double the stock price.