Stifel Equity Trading Desk analysts James J. Albertine and Lucy Webster rate LKQ Corporation (NASDAQ:LKQ) as a Buy as the company announces its FY14 outlook, which the analysts think shows a lot of positive factors.
We are encouraged by management’s FY14 outlook as it relates to (a) organic growth, (b) further expense leverage opportunities across legacy and newly acquired businesses, and (c) robust M&A pipeline/growth potential/scalability of LKQ Corporation (NASDAQ:LKQ)’s global asset portfolio. We remain buyers on share weakness. We do highlight, however, organic growth will likely decelerate sequentially in 1Q14 given weather related closures, reduced vehicle miles traveled. Not to say weather did not lead to greater collision and repair work, but rather the backlog will take longer than one month to work through.
LKQ Corporation’s depressed sales
LKQ Corporation (NASDAQ:LKQ) was not immune to recent inclement weather that caused disruption in their distribution channels. Sales are depressed thus far in 1Q14 as a result of road or store closures limiting parts delivery. Management did note that their most recent week of operations was free from interruption, and resulted in the highest weekly revenue ever recorded. There appears to be a backlog of work at collision shops, but the benefit may carryover into 3Q/2Q vs. 1Q.
Gross margin degradation appears to have slowed with a net -30 bp decline in margin in 4Q to 41.4%. Sator and U.K paint operations were a net -90 bp drag, but were offset by continued traction in NA. In FY14, management sees a net -110-120 drag on GM as a result of the recent Keystone acquisition (a low 30% GM business), which is baked into EPS guidance of $1.30-$1.40. Potential upside to margin estimates would largely be driven by better scrap pricing or used car costs. Management has baked in neutral effects y/y from both in their expectations, but we note higher off-lease supply suggests used car prices may soften.
Alternative parts usage
Management estimates alternative parts usage (APU) in NA was between 37%-38% in FY13, or relatively flat y/y. APU is calculated as repair dollars spent on alternative parts as a percent of total repair dollars. Three factors are at work that result in the flat y/y figure: (a) on average, LKQ Corporation (NASDAQ:LKQ) is selling a model part that is two years older and thus cheaper due to the increased age of the car pack, (b) SAAR lulls in 2010-2012 limit the number of cars in the “sweet spot” repair age of 3-8 years, and (c) recent SAAR acceleration has not yet created demand as new vehicles typically get OEM parts for at least the first two years. On a per unit basis, management noted that alternative part usage as a percent of total units has expanded, implying market share gains for LKQ vs. OEMs.