LKQ Stock: Dandy Business Model, and We All Believe in Economies of Scale, Don’t We?

Having said some relatively nice things in July about LKQ (LKQ), YCharts feels compelled to follow up. And, as with all roll-ups of fragmented, humdrum industries (past efforts include funeral homes, waste haulers and septic tank pumpers), one is surprised the damn things don’t consolidate more easily!

LKQ stock is still aloft, trading at a significant premium -- based on PE ratio -- to the overall market, based, one suspects, on the company’s comforting story (all those mom-and-pop auto junk yards and such really ought to be run by one, highly efficient company, and together they’ll be so much more profitable) and the fact that revenue growth continues.

LKQ Chart

LKQ data by YCharts

LKQ Revenue TTM Chart

LKQ Revenue TTM data by YCharts

So what’s the problem? Well, digging into third-quarter results, the economies of scale one expects in such an enterprise seem slow in coming. Revenue was up 29.7%, fabulous, but that was almost entirely from acquisitions. Organic revenue growth (same-store sales, to you retail fans) was just 1.6%. That latter figure does not a growth stock make.

And net income rose just 9.8%. That’s not the kind of operating leverage – net income growth more rapid than revenue growth – one aims for in business. The culprit? Cost of good sold rose more rapidly than revenue, as did distribution expense and SG&A.

A few details: LKQ, founded and backed by the former chieftains of Waste Management (WM), buys totaled cars and strips them for parts, reselling the bumpers and engines and such to auto-body and car-repair shops. What’s left over is scrap metal, and so the LKQ boys are back in the waste business, in a way, and it seems scrap steel prices have fallen. Chalk that up to the slowdown in China and elsewhere. So, less revenue from scrap. LKQ also runs a scrap operation of its own, and margins there are under pressure.

Distribution costs are up due to a big acquisition in Europe where, it seems, the car-repair shops expect parts to be delivered pronto, more so than in the U.S.

Also, for a variety of reasons – insurer decides to total the car, rather than fix it; mechanic ordered the wrong part; car owner decides against the repair – up to 20% of parts ordered by repair and auto-body shops get returned to suppliers such as LKQ.

Sounds like dreary details, ones we’d prefer to be spared altogether. But a rollup of a fragmented industry is all about the details. Our prior article, made clear the efficiencies LKQ brings to the auto parts business. But larding a corporate structure on top of all those formerly independent operations requires the efficiencies be quite dramatic to make the whole thing worthwhile. Rollups in trash hauling and funeral homes largely failed to live up to expectations for this reason.

Or, as an old Waste Management wag once complained to me: The most efficient operator in the business is a one-truck hauler where the owner drives the truck.

To be sure, LKQ is not alone in attaining a lofty stock price based more on revenue growth than on profit growth. (CRM) and Amazon (AMZN) are two glamour stocks that fit that pattern.

CRM Revenue TTM Chart

CRM Revenue TTM data by YCharts

AMZN Revenue TTM Chart

AMZN Revenue TTM data by YCharts

In fact, LKQ looks absolutely cutting edge compared to those two tech stocks. Note its profit margin.

LKQ Revenue TTM Chart

LKQ Revenue TTM data by YCharts

LKQ may yet turn its many salvage and parts operations into a company with lush, ever-widening margins, where incremental revenue falls heavily to the bottom line. It certainly has the potential.

Jeff Bailey is the editor of YCharts, which includes the just-released YCharts Pro Platinum for professional investors.



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