Organic Growth in a Fragmented Market [/b]In order to understand LKQ’s success and optimistic future outlook, we must take a closer look at the industry segment in which it operates. Unlike original-equipment manufacturers, or OEMs, companies who specialize in alternative parts must face a highly fragmented market. The recycled OEM product market for instance comprises more than 6,000 firms, with 90% of these generating less than $3 million in revenue. LKQ’s ability to grow on to achieve annual revenue streams near the $5 billion mark, thus demonstrate the manufacturer’s ability to consolidate a strong position in this industry segment. In fact, it is the only player in this industry niche with a national presence within the U.S.
Incremental market penetration has been one of the key elements in turning the firm into an industry leader. And, since it now enjoys a privileged position, due to an integrated IT system, and a large scale, LKQ is expected to continue enjoying mid-to high-single digit organic revenue growth rates. Maintaining its 30% share of the aftermarket and refurbished parts market, along with its 20% share of the recycled OEM parts sector, is thus crucial for the company. In addition, the fact that the alternative parts it manufactures are 20%-50% cheaper than OEM products, demand for LKQ engines, transmissions, doors, and so on, is expected to remain high.
A quick comparison of share price growth, with competitor [b]Johnson Controls Inc. (JCI), over the past three years depicts LKQ’s continued upwards trend.
Huge Network Ensures Large Scale [/b]LKQ, of which Meridian Funds is a major stockholder with 2.7 million shares of common stock, has a network which cannot be rivaled by local parts yards. This means new entrants will only be able to compete with the industry giant, if they invest the huge sums of time and money necessary to acquire the required zoning, environmental, and auto-salvage permits. Being shielded from competition is a key factor driving LKQ’s growth, and is expected to facilitate further positive financial results.
Apart from achieving lower manufacturing costs than most industry rivals, thanks to a large scale, LKQ is bound to benefit from increasing demand for its products. Aftermarket and refurbished parts, which make up more than 50% of the company’s total revenue, are increasingly popular among insurance providers. And, since insurance firms have the final say in terms of which products are to be used in vehicle repairs, LKQ can rest assured that their merchandise will not suffer from a sudden decline in demand.
[b]Does the Outlook Justify the Significant Price Premium?
It comes as little surprise that those seeking to invest in LKQ must take into account a considerable price premium. Currently trading at 34 times its trailing earnings, the stock is considerably overvalued, with an 83.7% price premium relative to industry peers’ average. Despite the high premium, 31.2% returns on invested capital can make up for the share’s elevated price tag. In addition, a solid balance sheet, which boasts comfortable margins and increasing revenue, makes LKQ a stable investment option. I personally feel very bullish regarding this stock’s future, and think its value will continue growing. Hence, the price premium might be worth paying, especially for those seeking to make a long-term investment.
Disclosure: Patricio Kehoe holds no position in any stocks mentioned.