In the spring of last year, I observed that LKQ Corporation (NASDAQ:LKQ) was on the dealmaking hunt again. The company acquired the underperforming Uni-Select business, at a small discount to its own valuation, with the benefit of hindsight, too small of a discount. The company has seen tougher macro times while impacted by warmer weather and strikes, creating a tougher environment to operate within.

Nonetheless, the company continues to perform at acceptable levels as a pullback of 30% over the past year, leaves shares sufficiently attractively priced to get involved here.

About LKQ

LKQ was founded in 1998, at the time being a $300 million recycled products business, as it has seen spectacular growth ever since. Through 2023, the company has grown to a revenue base of nearly $14 billion. Nearly half of these sales are generated in the European parts & services business, complemented by recycled products, aftermarket North America, self-service parts and others.

The company has grown to its current stance, after no less than 300 acquisitions, typically bolt-on deals, but recently also including larger acquisitions. By now the company has become a diversified distributor of vehicle products, replacement parts and components.

LKQ employs nearly 50,000 workers, active in over 1,600 facilities, with these employees predominantly working for customers in wholesale collisions and mechanical DIFM shops.

The incredible rise of LKQ has long made it a darling among investors, as a $2 stock back at the time of the IPO in 2003 has seen huge share price gains. Shares rose to the $10 mark in 2010, rose to the $30 mark around 2015 and after a few years of stagnation rose to the $60 mark late in 2021.

What followed was more stagnation and quite frankly a tough year over the past twelve months, as a $60 stock in the summer of last year has fallen to $41 per share at the moment of writing.

Picking Up The Performance

Early into 2023, the company posted its 2022 results, with sales down 2% to $12.8 billion, with declines due to minor divestment and adverse currency moves. Operating margins came in around 11%, as adjusted earnings of $3.85 per share were down a little bit.

For 2023, the company guided for sales to increase by 6-8% in organic growth terms, with adjusted earnings seen at a midpoint of $4.05 per share. Commanding an $18 billion enterprise valuation at $58 per share, LKQ announced another deal halfway 2023, as it was looking to acquire Canadian-based Uni-Select in a $2.1 billion deal. The deal was set to make that leverage ratios would increase to 2.4 times, still manageable.

With earnings power seen around $4 per share, shares traded at a 15 times multiple last summer, amidst reasonable leverage ratios. While the overall valuation were rather fair, I failed to have conviction on the shares.

Performance Drops Off

In the fall of 2023, LKQ issued a big profit warning, as it cut the full-year organic sales guidance by 1.25% to 4.75%-5.75%. The midpoint of the full-year earnings guidance was cut by a quarter to $3.75 per share, all due to strike activity in Germany, dilution from the Uni-Select deal, soft commodity prices, and generally more difficult market conditions. In November, the company announced leadership succession plans, always creating some turmoil as well, although this was all related to an appropriate retirement age for its CEO.

In February, the company reported an 8.4% increase in 2023 sales to $13.9 billion with adjusted earnings of $3.83 per share, topping the revised guidance as of the third quarter. Frankly, the 2024 guidance looked okay to me, with organic sales seen up 3.5%-5.5%, with adjusted earnings seen at a midpoint of $4.05 per share. This suggests that earnings growth is more or less seen in line with organic sales growth, with Uni-Select adding modest earnings, largely offset by incremental interest expenses. Net debt of $4.0 billion is a substantial amount yet manageable for a 2.3 times leverage ratio, with EBITDA reported at $1.7 billion.

Following the third quarter profit warning, shares traded around the $50 mark, as these shares have come under further pressure following a softer first quarter earnings report, as released in April. In response to softer demand, LKQ has taken measures to improve margins and derive more synergies from the Uni-Select deal.

This allowed the company to maintain the full-year earnings guidance, while it cut the full-year organic sales guidance by a point to 2.5%-4.5%. Net debt came down further to $3.9 billion, very much welcomed as EBITDA fell amidst general pressure on margins and the dilution from Uni-Select.

While this still looks solid, the first quarter results cause reasons to be concerned. While revenues rose by 10.6% to $3.7 billion, organic revenue declines came in at 0.3%. This weighted heavily on margins and earnings, with adjusted earnings of $0.82, down twenty-two cents on the year before. Amidst this, the risks to the full-year organic and earnings guidance are increasing in my view, even as the sales guidance has been lowered.

With leverage down to 2.3 times and the earnings multiples down to about 10 times, as shares have come down towards the $40 mark, appeal is naturally increasing, although that the Uni-Select deal looks ill-advised, with the benefit of hindsight. Note that the adjusted earnings guidance is misleading as well, as the company sees GAAP earnings at a midpoint of $3.47 per share, but part of the gap comes from amortization charges, which I am happy to adjust for. On the other hand, there are some structural and cash-involved restructuring charges as well.

What Now?

Frankly, the growth darling has lost quite some of its touch, and really has become a more mature company, with LKQ Corporation sales growth being underwhelming for years now. On the other hand, leverage is manageable, and a premium multiple has reverted to a mere 10 times adjusted earnings guidance, and about 12 times GAAP earnings guidance.

Following the CEO transition, the question is what the focus of the business will be on for the coming period after Nick Zarcone led the business for nearly 10 years. The conference call offered a glimpse of this and shed more light on the first quarter performance. The very soft quarter was attributed to unusual warm weather, resulting in fewer collisions. Moreover, sky-high insurance costs meant that deductibles were on the rise for consumers, often resulting in them not resolving the issues entirely, while the company suffered from wage inflation in Europe.

Incoming CEO Justin Jude was dealt a tough hand at first, but he seems to be focusing on operating excellence, as the company divested some non-core assets in Europe in Bosnia and Slovenia, while embarking on a big SKU rationalization project in Europe.

Given all this, I expect the LKQ Corporation business to see some kind of stabilization and return to modest long-term growth, which should set investors up for reasonable returns amidst current non-demanding multiples.