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A 5-Star Stock With an Appealing Future

A 5-Star Stock With an Appealing Future

Scott Pope: LKQ Corporation presents a fascinating story that demonstrates what a strong management team can accomplish with a mature roll-up strategy. Currently, narrow-moat LKQ is an attractive 5-star stock that trades at a 30% discount to our fair value estimate. The firm has come a long way since it was founded two decades ago as an acquirer of auto salvage companies. After more than 275 acquisitions, LKQ has become a leading distributor of new, recycled, and specialty auto parts to professional repair shops in North America and Europe.

Core to LKQ’s strategy is its ability to supply collision and mechanical parts at up to a 30% discount to traditional OEM pricing. As LKQ has grown larger and implemented numerous technology initiatives, it has not only been able to provide superior pricing but also the highest fulfillment rates. This combination has led to a virtuous cycle as repair shops look to LKQ as a single-stop supplier. At the same time, insurance companies have embraced the LKQ model and encouraged adoption of alternative, non-OEM parts to contain costs and minimize out-of-service times for policyholders’ vehicles.

Our thesis for LKQ is rooted in our conviction that management can replicate its North American success in Europe. As it consolidates parts catalogs and distribution systems across the continent, LKQ should realize both revenue and cost synergies. This should close the profitability gap between European and North American operations. We estimate this transformation will boost LKQ’s operating margin by over 200 basis points in the next five years, while allowing the firm to generate potentially over $4 billion in free cash flow over the same period.

Therefore, we believe that LKQ’s current trading price, which equates to 11 times our adjusted EPS estimate for 2019, is an attractive entry point for investors that shouldn’t be overlooked.

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