|Shares Out. (in M):||305||P/E||0||0|
|Market Cap (in $M):||8,000||P/FCF||0||0|
|Net Debt (in $M):||0||EBIT||0||0|
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LKQ is a reasonably priced non-OEM autoparts distributor that does not receive enough credit for (1) the upcoming growth acceleration of the 3-8 year addressable fleet size in the US and (2) the long, visible runway of capital allocation in Europe to replicate what they have accomplished here. The first point is very “dealer-thesis 2.0” sounding – whatever propelled the HSD-to-LMD growth in Parts & Services for the auto-dealers is set to mirror itself for LKQ as the 0-5 year-old fleet turns into the 3-8 year fleet, setting a trajectory of 8-10% US CAGR (~2 pts above consensus) over the next 4 years barring any incremental share gain and/or sudden accident frequency decline. The ~5% FCF yield coupled with maintained 2x Net-Debt / EBITDA leverage allows for ~$0.8 – 1 Bn of firepower (~10% of market cap) to be deployed in this fragmented industry with a many-to-many structure. Given that (a) the efficient ramp-up from sub-scale to of-scale can drive compelling IRR of 20%+, ROIC of 10%, and margin expansion of up to 500 bps and (b) LKQ’s historical track record of 170+ acquisitions rolling up the US while maintaining 10%+ ROIC/ROIIC and 15% ROE, deploying cash into Europe where the market penetration of OEM parts is ¼ of the US and LKQ’s share is roughly 1/3 of the US could drive further upside vs. consensus (where most sell-side do not model acquisition / any capital deployment). The 7-8% organic growth + 10% acquisition growth + margin upside offset by dilution, assuming multiples remaining at 18x historical average, should drive 15-17% IRR over the next few years with optionality on operational improvements and scrap metal prices potentially turning around.
That being said, pricing and margin likely saw their best days as OEM parts manufacturers are getting more aggressive while customers (repair shops) are consolidating (although these should help LKQ gain share), LKQ’s increased size, share, and OEM-exposure would render execution risk higher and downside-upon-crisis greater, and, most damning of all, accident rate is likely to take a 1-way street down and permanently drag top-line growth by 3-4%. All these will point to lower and more volatile out-year organic bottom-line growth -- which means the current multiple of 18-20x forward PE sees great risk of compression towards 14-16x, effectively cutting the IRR in half (8-10% IRR).
While one can argue LKQ deserves a premium over the next 2-3 years given the extremely favorable tailwind and capital allocation trajectory (~$50+ / share at 20x+ PE), the silver-lining is that the risk of a financial crisis and accident rate decline / driverless cars also increases dramatically. The debate then becomes (1) how short-sighted the market can be, (2) what kind of hedges we should put on, and (3) whether the consensus revision upwards + continuous execution drivers have enough hedged IRR to justify the opportunity cost. My hypothesis is that once SAAR stops going up & general economy shows 1st sign of weakness, the multiple beyond 20x is not likely to be seen.
Hence, It could be an interesting pair with the dealers/OEM with 15-17% IRR, downside rerating jump-risk upon accident sentiment or headlines, and secular risk; or hedge should we choose to invest.
Key Catalysts: Visible acceleration of US organic topline growth, guidance / realization to margin upside thanks to consulting / UK warehouse, entry to other European countries w/ additional disclosure to consolidation roadmap.
Visible acceleration of US organic topline growth, guidance / realization to margin upside thanks to consulting / UK warehouse, entry to other European countries w/ additional disclosure to consolidation roadmap.
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