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LKQ Reports Record Total Revenue; Margins Remain Under Pressure

On the surface, Chicago-based LKQ Corp. had a strong third quarter, but margin pressure continued. Net income increased 9.9 percent to $134.48 million. On an adjusted basis, net income attributable to LKQ stockholders rose 26.9 percent to $177 million.

Total revenue increased by $656.58 million, or 26.7 percent, to a record $3.12 billion. Total parts and services revenue growth was 26.9 percent, with acquisition revenue growth of 23.2 percent and organic parts and services revenue up 4.3 percent.

And, while LKQ’s gross margin rose 25.1 percent to $1.20 billion, gross margin (as a percentage of total revenue) declined from 38.8 percent a year ago to 38.3 percent for the three months ended Sept. 30, 2018.

NORTH AMERICA … North American parts and services revenue grew 5.5 percent to $1.11 billion in the third quarter, with organic revenue up 5.2 percent. Segment EBITDA increased 0.9 percent to $154.05 million; however, segment EBITDA margin declined from 12.9 percent to 12.2 percent on a year-over-year basis.

“The new battery distribution agreement with FCA contributed about 150 basis points to the organic growth, though it comes with a lower margin structure, as we essentially just get a service fee,” President and CEO Nick Zarcone told analysts on the company’s Oct. 25 quarterly report conference call.

“All said, we continue to perform well in North America, especially when you consider that — according to CCC Information Services — collision- and liability-related auto claims on a national basis were up only 0.3 percent in the third quarter of 2018 compared to last year and up only 0.4 percent on a year-to-date basis,” Zarcone said.

“As was the case in the first half of the year, there continues to be meaningful variances in growth rates across the geographic regions of North America, with key markets — such as New York, California, Pennsylvania, Florida and Michigan — each down low- to mid-single digits,” he stated. “We believe the significant outperformance in our growth relative to the CCC data for repairable claims is due to the continued increase in the number of vehicles in our collision sweet spot — that being model years three to 10 years old — and continued market share gains.”

Zarcone added that organic growth for aftermarket parts continued to outpace that of salvaged parts.

“We believe there are more margin improvement opportunities, and we are not done,” Zarcone told analysts. “I’m very proud of our North American team, and how diligently and aggressively they are working to offset inflationary pressures, which we anticipate will be with us for the foreseeable future.”

EUROPE … LKQ’s European parts and service revenue rose 53.7 percent to $1.46 billion, with organic revenue up 2 percent. Segment EBITDA increased 63.1 percent to $129.36 million, and segment EBITDA margin grew from 8.3 percent to 8.8 percent on a year-over-year basis.

According to management, the 54.7-percent spike in revenue came primarily from the acquisition of Stahlgruber, while the 2-percent organic revenue growth reflected a sequential pullback from the second quarter of 2018.

Zarcone told analysts that — while management anticipated organic revenue growth in Europe to decline from the strong levels seen in the second quarter — the division’s performance in the third quarter was a bit below expectations. He added that the slightly lower organic growth came from several factors, including …
• Soft economic growth in markets experiencing political instability, such as Italy and the United Kingdom.
• Unseasonably warm weather throughout most of Europe during the quarter.
• The decision to not submit to price-cutting pressure from competitors.

“That said, there were several positive longer-term developments during the quarter. For example, in the U.K., our depth of inventory, national footprint and service levels — owing to the T2 investment — have enabled us to continue winning national account business, evidenced by several recent wins …,” Zarcone stated. “The new contracts will have little impact on our 2018 results, and the primary benefits are expected next year.”

He added that Stahlgruber is performing consistent with management’s expectations.

SPECIALTY … Specialty revenue increased 18 percent to $388.87 million, with organic revenue up 8 percent. Segment EBITDA rose 22.3 percent to $42.94 million, and segment EBITDA margin grew from 10.6 percent to 11 percent on a year-over-year basis.

Management pegged the higher-than-anticipated organic growth to increased customer penetration and an expanded exclusive brands offering, as well as increased RV parts demand, positive U.S. economic conditions, strong consumer spending, and continued favorable light truck and SUV sales trends.

CFO Varun Laroyia told analysts on the call that the Warn Industries business performed well, while the rest of the Specialty segment generated an 8-percent organic revenue growth rate for the quarter, which Laroyia called “a nice rebound from the lower rate that we experienced in the first half.”

ACQUISITIONS & DIVESTITURES … In August, the company finalized the sale of the Andrew Page branches that antitrust authorities required LKQ to divest. Meanwhile, LKQ continues to integrate and rationalize the remaining 77 Andrew Page branches.

Additionally, the entire Andrew Page branch network is now being replenished out of LKQ’s T2 distribution facility, and Andrew Page’s former national distribution center has been vacated and returned to the landlord.

During the third quarter, LKQ opened seven new branches in eastern Europe and acquired three wholesale businesses in Europe.

GUIDANCE … Management has reduced the upper end of its full-year organic parts and service revenue guidance from a range of 4.5 percent to 5.5 percent (previous expectation) to 4.5 percent to 5.0 percent (new projection).

The company also lowered its full-year guidance for net income from continuing operations attributable to LKQ shareholders. Management had expected between $602 million and $627 million in net income. It is now calling for between $565 million and $585 million.

“The updated guidance reflects the reality that our initiatives to deliver sustained growth and increased profit margins are working, though offset by the continued cost headwinds impacting our industry,” Laroyia stated. “While the initial results of our actions are positive, we believe that these cost pressures will not abate in the near term, and have adjusted our guidance to address the economic headwinds related to freight, fuel, and wage inflation, and declining scrap prices.

“We are committed to protecting our margins, driving higher levels of free-cash flow conversion, and believe our actions will position us well for achieving higher levels of sustainable and profitable growth in the future.”

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