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LKQ’s N.A. Organic Revenue Declined, Yet Gross Margin, EBITDA Increased

The second quarter of 2019 presented a mixed bag of sorts for Chicago-based LKQ Corp. Consolidated revenue rose 7.2% to $3.25 billion mainly due to acquisitions made. Organic total revenue declined 2.4%.

Gross margin grew 7.3% to $1.25 billion, while gross margin (as a percentage of revenue) increased slightly, going from 38.3% to 38.4% on a year-over-year basis. Net income declined 3.6% to $152.11 million; however, on an adjusted basis, net income increased 6% to $204 million.

President and CEO Nick Zarcone told analysts on the company’s July 25 earnings call that the second quarter played out largely as management anticipated. “There were both some clear positive movements and some disappointments, but we’re encouraged by the overall result,” Zarcone said. “On the plus side, our North American segment experienced a significant uptick in both gross margin and EBITDA margin, which gives us confidence that our disciplined approach to the market and keen focus on controlling our costs are creating positive outcomes.”

“On the flip side, we knew we had very difficult year-over-year revenue growth comparisons with respect to both our North American and European segments. The organic revenue growth came in below our tempered expectations,” Zarcone noted.

He also stated: “There is no doubt that the soft macroeconomic conditions across Europe are weighing on our industry and our revenue comparisons. We are performing better than many of our peers, but organic revenue in Europe was down, and that softness bled through the operating margins.”

NORTH AMERICA … North American third-party revenue of $1.17 billion was essentially unchanged when compared to the second quarter of 2018. Organic revenue declined 0.4%, as the PGW Glass business and the airplane recycling operation exhibited a decline in same-day growth, while the largest part of LKQ’s North American segment (the automotive salvage and aftermarket parts operations) came through with 0.7% same-day growth.

“We continue to perform well in North America — especially when you consider that, according to CCC, collision and liability-related auto claims were again down 2.6% year-over-year in the second quarter. This softness was nationwide, with 40 of the 50 states recording a decline in repairable claims,” Zarcone pointed out. “Additionally, miles driven has slowed, with the lower growth coming from increased vehicles in operation versus miles driven per vehicle, and an increase in the number of people working from home and the shift toward online shopping.”

Despite some challenges on the top line and a tough comparison against the second quarter of 2018, the company’s North America team reported year-over-year margin improvements. Segment gross margins were 44.1% (up 100 basis points) and EBITDA margins were 14.4% (up 130 basis points), representing some of the highest levels in LKQ’s history.

EUROPE … European third-party revenue rose 18.0% to $1.51 billion, primarily due to the acquisition of Stahlgruber. Organic revenue decreased 4.3% (down 2.8% on a same-day basis), attributable to a soft macroeconomic environment in Europe.

“Our performance on a relative basis appears to be fairly strong, which gives us confidence that we are not losing share,” Zarcone said on the call. “Additionally, the diversification of our geographic footprint in Europe generally reduces the volatility in our segment performance because we are not overly exposed and reliant on any one specific country. While we don’t disclose country-by-country detail, I will note that Italy was the softest in terms of organic revenue growth and the Eastern Bloc was the strongest, albeit still below its historically high levels.

“Europe has seen many of its economies slowing as evidenced by negative or flat GDP growth and lower new vehicle sales. Discussions with our suppliers and other industry participants have confirmed the downward pressure that poor economic growth across the continent is having on the European parts marketplace. The consensus view is that the soft economic conditions have led to an initial deferral of repairs and maintenance. While a near-term headwind, we believe that core automotive maintenance can only be deferred for so long and that demand will eventually rebound. That said, we anticipate the soft industry conditions will continue through the balance of 2019.”

European gross margin of 36% was unchanged year-over-year. Segment EBITDA as a percentage of revenue declined 90 basis points to 7.7%.

During the quarter, LKQ opened three branches in western Europe and one in eastern Europe while closing five underperforming locations (one in western Europe and four in eastern Europe).

SPECIALTY … Specialty segment third-party revenue declined by $1.37 million, or 0.3%, to $410.26 million, as 0.1% organic revenue growth was offset by a negative impact from currencies. “Specialty witnessed particular softness in Canada, which accounts for about 10% of the segment’s revenue, largely related to Canada’s weak economy,” Zarcone said. “Additionally, RV parts sales were off slightly due to lower dealer retail sales across all regions.”

Specialty gross margin declined 130 basis points, while segment EBITDA as a percentage of revenue decreased 90 basis points to 12.7%.

Management expects Specialty to bounce back in the second half of the year.

ADDITIONAL INFO … A few other items of interest from LKQ’s second quarter financial results conference call …
LKQ intends to close branches and warehouses that are not supporting a sufficient return on investment.
The company has retained a consulting firm to assist with management’s review of the company’s various businesses in Europe.
• Management’s guidance for 2019 organic revenue growth for parts and service — previously set at +2.0% to +4.0% — has been reset to +0.5% to +2.0%.
• Adjusted net income is now expected to come in between $718 million and $743 million. Prior guidance called for $732 million to $771 million.
• It was a relatively quiet quarter from a transaction standpoint. The company closed on just three smaller deals, including two companies in the United States and a regional distributor in Belgium for a total net consideration of $38 million.
• LKQ has entered into a definitive agreement to divest an undisclosed “small operation in Europe,” which management expects to close in the third quarter.           — Marc Vincent

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