has been stuck in neutral for years, but 2021 could see things turn around for the company as the pandemic forces it to take steps that some say it should have taken long ago.
Although LKQ (ticker: LKQ) distributes car parts, don’t think of it as another
Advance Auto Parts
(AZO). The company—which takes its name from “like, kind, and quality,” the three criteria that insurers require for vehicle replacement parts—buys used cars and wrecks, salvages them for reusable parts, and scraps the rest. It’s where you go when you don’t want to spend a lot on that muffler or rearview mirror.
The stock dropped 1.3% last year as Covid-19 led to fewer miles driven for many people—meaning less wear and tear on vehicles and fewer accidents, causing scrap-metal prices to increase.
But most of LKQ’s problems have been self-inflicted. For years, LKQ was a consolidation story, snapping up smaller players and building a dominant business, both in the U.S. and Europe. Yet the synergies that should have resulted from this acquisition binge never emerged. The company’s operating margins declined each year from 2015 to 2019, and expenses were higher than they should have been. Covid-19 has forced LKQ to get leaner—and that could allow the stock to benefit from the reopening of the economy in 2021.
“LKQ, like a lot of other companies, realized that they can do more with less” during the pandemic, says Josh Wein, portfolio manager at Hennessy Funds, which added the stock to its holdings in October. “Companies use it as an excuse to do what they should have done anyway—get rid of some fat.”
Disappointment has been the name of the game for LKQ in recent years. The stock has been range-bound at about $20 to $43 since late 2012 as metrics such as return on assets and return on equity fell and debt rose. It has become easy to doubt an LKQ turnaround. “We’ve owned the stock since 2014, and it has been a perennial disappointment,” says Lamar Villere, partner and portfolio manager at Villere & Co., which recently sold the stock. “The problem is, it’s six years later and [things are] moving more slowly than hoped.”
Still, 2021 might be the year that LKQ finally lives up to the promises it made. The stock has already gained more than 6% this year, putting it on course to finally break out of its trading range.
The company has reduced operating expenses by about 6% in the first nine months of 2020, and LKQ’s streamlined operations mean that margins are also a major focus. Both net margins and earnings before interest and taxes, or Ebit, at 4.3% and 7.8%, respectively, were lower in 2019 than they were five years prior. Yet analysts expect these to improve in 2020, to 6.2% and 9%, both above the company’s five-year average.
Moreover, after years of mergers and acquisitions, LKQ has pulled back from M&A, unlocking free cash flow and allowing the company to pay down debt and repurchase stock. Analysts expect that net debt will fall some $600 million in 2021 to $3.5 billion, on free cash flow of $859 million, roughly double the levels it saw from 2015 to 2018.
“LKQ is in the early-to-middle innings of a multiyear plan, and the improvement in profitability, coupled with a return to [sales] growth next year, should drive multiple expansion,” says Stephens analyst Daniel Imbro, who points to the recent string of better-than-expected earnings reports from the company.
Consensus estimates call for LKQ’s earnings per share to have edged up just 2.5% year over year in 2020 to $2.43, with revenue dipping 7.5%, to $11.56 billion. Yet 2021 looks brighter, with EPS expected to jump 13% to a record $2.75 on a 5.8% rise in sales to $12.22 billion.
Despite the positive outlook, LKQ’s price/earnings ratio fell from about 20 times at the beginning of 2020 to 14.5 times at the end of the year, at a time when the
index’s multiple rose from roughly 21 times to 31 times. The good news is that the low expectations embedded in the multiple could work in LKQ’s favor, especially if it manages to right its European division.
The stock is cheap: At 13.7 times 2021 earnings, it’s trading below its five-year average of 14.4 times, and below the P/E of peers like
(ORLY), whose multiples are in the high teens, and
(FAST), which change hands for more than 30 times this year’s earnings.
“As execution improves, you’re going to see the multiple recover,” says Imbro. He has a $44 price target on LKQ stock, up 17% from Wednesday’s close of $37.60.
None of this takes into account the economic factors that should help LKQ in 2021. The pandemic will end, and the reopening will unleash pent-up demand from motorists eager to travel again. And Americans, still dealing with an uncertain economic outlook, could be motivated to fix, rather than replace, damaged cars.
If 2020 taught us anything, it’s to expect the unexpected. That includes a longtime lemon finally moving into the fast lane.
Write to Teresa Rivas at [email protected]