LKQ Corporation (LKQ) Earnings Call Transcript & Summary

All right. So moving along, we now have LKQ Corp., which keeping along with the theme we touched on yesterday, financial engineering. LKQ Corp. recently acquired Uni-Select for $2.1 billion in August of 2023, which is a Canadian-based distributor of parts and accessory across Canada and then also has the FinishMaster brand, which is a distributor of paints, coatings and related products serving the collision market. Those are all -- those businesses are within their Wholesale North America business, which sells aftermarket OEM recycled and manufactured and refurbished products to collision and mechanical repair shops around North America. And additionally, they also recently closed on the divestiture of their Self Service business in October -- on October 1 for $410 million to Pacific Avenue Capital Partners. And then apart from that, they have the European business, which operates as one of the largest independent aftermarket distributors, selling over 900,000 SKUs across 20 countries in Europe. And then lastly, the Specialty business, which is a distributor of parts and accessories serving the specialty vehicle aftermarket. The company is about $7.5 billion equity market cap and about $3.5 billion of net debt. It's my pleasure to introduce Justin Jude, the President and CEO; and Rick Galloway, Senior Vice President and CFO.

Good morning, everyone. And to the Gabelli team, I appreciate you guys having us. I know it's been a while since we've been here.

Thanks for being here.

But it's my first time here, so I'm excited to be here. I'll do a quick intro of LKQ, a little bit more detail and a little bit about myself, and then we'll open up the fireside chat and Q&A. So I'm Justin Jude, I've been with LKQ since 2001, held many different titles, responsibilities from IT to supply chain to -- I ran our Specialty division. I ran our North American Wholesale segment. Then I became the CEO in July of last year. It's been a great company, a great company to work for. The history of LKQ, we were founded in 1998, but we've been an acquisitive company. Over 320 acquisitions since the beginning, and it's always been focused on fragmented markets, always around the automotive side, but always focused on the fragmentation, how do we take scale, how do we build size, how do we kind of revolutionize or create a little bit more sophistication in industries that didn't exist. And we started with the salvage piece in 1998 and what we call the wholesale -- the full-serve side, where we buy a vehicle, whether it's wrecked, whether it's end of life, we dismantle that, provide parts to it. But we've had a great, great growth trajectory, once again, heavily fueled by inorganic acquisitions, but as well as organically as well. Our 2 biggest businesses are Wholesale North America and Europe, and I'll talk about them in a little bit more detail. The other business we have that he mentioned was Specialty. Once again, I ran that for about 1.5 years. That's more SEMA products. So accessories, lift kits, big truck tires, RV products, more or less the discretionary spending type products. The 2 core businesses that we have are very nondiscretionary, more in the maintenance, repairing your vehicles, and that's in our Wholesale North American side and in our European side. On the Wholesale North American side, it's mostly collision focused, as you can see from the slide. And that is paint, that's aftermarket collision parts and that's used. The benefit of used, which -- where we started from originally, if you remember, is when you produce a dismantle a vehicle, you'll have collision parts and you'll have major mechanical. And so that collision piece led us into -- we wanted to go to say yes more often. So we acquired aftermarket parts. And that's when I came aboard in 2004. And just constantly looking at opportunities to say yes, service an underserved market, making sure that once again, we brought sophistication capabilities, bringing better fill rates, better service, and that's what we've grown into the North American side. He mentioned Uni-Select. It did come with Bumper to Bumper, our hard parts business in Canada, right up in Canada, we're #2 player today. Our Bumper to Bumper business, which is hard parts, is very similar to what we do in Europe. So it is primarily do-it-for-me. The market itself is primarily do-it-for-me. We specialize in that do-it-for-me. But if you look at the gaps and opportunities, I look at it is like we're big in collision in North America, small in collision in Europe, big and hard parts in Europe, small with hard parts in North America. We really see that opportunity to capitalize on each other's strengths and to grow this business organically. We've got to focus a little bit on our European side to integrate that business. We've done a great job in North America as we acquired businesses along the way, integrate them, get the scale out of it, get the synergies, get the efficiencies out of it. On the European side, we kind of filled the map. We looked at expansion, other opportunities to acquire businesses and expand, but we haven't really done heavy lifting yet. So we kind of delayed that -- COVID happened, supply chain. A lot of the North American integration was done, I was involved with and part of that. And so I'm taking that -- some of that experience from my team and myself going over to Europe to make sure we can integrate that business, really focus on driving costs out of the business, create better customer experiences, make a stronger, more scalable, robust business. And then we really see a lot of greenfield opportunities and a lot of white space in our European market, not just with hard parts to grow in the new areas, gain more share, but taking some of the things that we do really well in North America, remanufacture. We produce over 120,000 remanufactured engines a year. We do about 15,000 in Europe. So we see that opportunity just once again, cross-pollinating, getting some of the scale and benefits that we've done in both businesses, cross-pollinating that and really turning this into a growth story in years to come. With that, I'm going to just probably -- let me talk a little bit about why we went. So uniqueness of North America, and this is what we're trying to create in Europe is, especially on the salvage side, you're hindered on the ability to say yes by just what's available in the market. So a customer can call me today and ask me for a used engine or a remanufactured engine. But if there isn't a vehicle that I can go procure and dismantle that vehicle, and have that ability to say, yes, it's not like aftermarket where I just call my manufacturer and say I need more fenders. I need more hoods. You have to have that vehicle. So the way we allow ourselves to say yes more often is our network, is our network capability where a customer in Ohio can call the sales rep, log on to our website, log into a portal, look up an engine, see that an engine is available next day and they have no idea that's coming out of our Orlando location. That scale that we've created is what we want to recreate in Europe, and we're on a path and we're on a trajectory to do that. But being able to lower our inventory levels overall and still keep the ability to say yes and drive that efficiently. On the -- once again, why we win, it's the fill rates, it's availability, very competitive prices, and we always go for high quality, whether it's on the used side or whether it's on the aftermarket side. I think with that, I'm just going to probably open it up to fireside chat.

Perfect. Thank you for that overview. I guess just starting off, can you talk about some of the strategic initiatives the company is going through right now and what kind of some of the early benefits you've been seeing recently?

Yes, great. As I mentioned, we've been a very acquisitive company. And along the way, 90-plus percent of those companies are great. You then realize as you kind of grew up, some of those businesses don't fit long term. And so my strategy has been kind of what I call simplification. So simplifying operations, integrating more, but also simplifying the portfolio. If there are businesses such as self serve -- and our Self Service business was strong, #1 provider. But with the situation that we're kind of facing in our industry right now, we weren't investing in that business. But it's a strong business that has great opportunity. But from a capital standpoint, it wasn't our highest priority. So we did not -- and I don't want to say it was a distraction. We just weren't focusing on it. We just weren't giving it the attention that it needed. And so once again, it was a great business. We were able to divest that, get good proceeds, as you mentioned earlier. So we felt really confident about that. But we also want to continue to look at those 320 acquisitions. And are there businesses, are there product lines? Are there countries? Are there branches that we don't necessarily need to operate to provide the good customer service that we strive for. And so we want to continue to simplify our operations. And so looking at the portfolio, both bringing in and divesting is what we're focusing on pretty heavily right now.

Great. And then just kind of touching on the wholesale North America market. Can you just talk about some of the current collision trends in North America and kind of what needs to happen in order for the -- do you see some market recovery?

Yes. So the good news is we don't necessarily see the numbers around, but we don't see accidents really in the last 3-year stack decreasing much more than 1%. So actual volume of accidents is relatively flat. We understand long-term headwinds of ADAS and technology and accident avoidance systems are going to reduce the vehicle accidents. Right now, we're just dealing with economic situation. And so some of the things that are impacting consumers besides high groceries and the like is their insurance premiums have gone up enormously in the last 3 years. And so you've seen the highest uninsured motorists of all times, and I've been in the industry since 1996. It's the highest of uninsured motorists that I've ever seen, I think the industry has seen. It is the highest percentage of consumers that actually have insurance, but they have liability only. So if you look at somebody gets in a wreck and they either uninsured higher frequency. If they get in a wreck and they have liability only, they'll fix somebody else's car that they hit, but they won't fix their own vehicle. And so some of those things with [indiscernible] and then when you get in the wreck, do you want to fix your vehicle if your vehicle is 10 years old and the aging of that has decreased the used car value pretty extensively. If you look at what we do in North America, whether it's collision, whether it's major mechanical, the average repair is between $4,000 and $5,000. So that used car value is very impactful on that consumer's decision of whether I'm going to fix that vehicle or not. So when I see used car pricing starting to stabilize and get back to normal GDP, 2%, 3% increase per year, I see insurance premiums staying flat to slightly going up 1% to 2% for consecutive quarters and the overall consumer sentiment and consumer spending is good, I see those things starting to turn around and driving repairable claims back up.

Got you. So you talked about ADAS and how that's kind of impacting your business. What about the general complexity of the vehicle and EV and if you could touch on EVs as well, how that's impacting?

Yes. complexity for us is good in a couple of different ways. One, it drives higher part pricing. And so if you look at a 2015 GMC pickup and you had a collision, you get a front accident collision and you put it -- you produced it with -- or I'm sorry, you replaced a steel bumper in it. Then it became high-strength steel. Then it became extruded aluminum. And so the complexity of the vehicles, the complexity of the parts themselves actually drive higher price part pricing, and that's good for us. The MSOs, when the cars are getting more technical, MSOs are going to get more share because they have the sophistication to train their techs, understand what tools are needed. We win with the MSOs. MSOs require large-scale, consistent providers, high quality. So we always win with them. In addition, the complexity of the vehicle makes it difficult for some salvage yards to dismantle vehicles. If you think of electrification and you touch a screw driver to the wrong thing and all of a sudden, that thing got 1,000 volts going through the motor from the battery to the motor, so it's dangerous. So our scale has allowed us to be able to harvest more parts of those vehicles, understand the opportunity to produce those or procure those parts out of the vehicle. So complexity for us is a good thing. You mentioned EV. Obviously, that slowed down here somewhat, which is good and bad, I guess, whatever your perspective is. we see the benefit, especially with our European operations to see the impact of EV at a faster pace because the adoption of EV is higher in Europe. And so then we're learning from that to understand what are opportunities, what are risks for product lines. You still sell suspension, you sell wipers, you sell tires, I mean a lot of products that are still being sold at a higher rate and you talk about complexity, just the brake pads of EVs come at a much higher price than ICE vehicle brake pads. So we see that -- understanding what's happening in Europe, the adoption of it, giving us kind of information of what we need to do better at and invest in. And a good example of that is about 5 years ago, we invested and acquired a couple of businesses that do remanufactured hybrid batteries. And so if you think of the journey of the life cycle of a vehicle, it went from ICE or combustible engine to hybrid where it was a battery, nickel-metal hydride and gas, then went to lithium-ion batteries for the hybrids and then it went to full battery electric vehicle. So right now, we remanufacture hybrid electric batteries. We actually do the installation of those. That technology of understanding how lithium works has allowed us to begin to invest in research and remanufacturing of electric vehicle batteries, full electric vehicle batteries. So there's not a lot of demand right now. But I know if you fast forward on EV, one of the biggest headwinds of EV is just the residual value of used EV. And a lot of that is because if that battery fails and the only option for a battery is OEM, it's very expensive compared to that used car value. So we see maybe losing the ability to sell engines used in remanufactured engines and an EV. We see that replacement opportunity on the electric battery side. So once again, we've generated -- we've reproduced a few -- sorry, remanufactured a few electric vehicle batteries. They're in vehicles today, testing them out, making sure we understand how the battery management system works, how the cooling system works, what all needs to be repaired, what needs to be replaced to make sure that once again -- and that technology we're doing in North America, we then transplanted over in Europe and give them the opportunity to either service or repair or sell remanufactured electric vehicles. So we see EV being a headwind for some people that keep their head in the sand. We're looking at it as an opportunity to make sure that we invest in it. So when the volume comes or if it comes, we'll be ready for it.

So you kind of touched on there with the remanufacturing and the electric vehicles. Can you just talk about the 5 different product types you have within the North American Wholesale segment, and then kind of what the difference in customer base is for these different categories of the aftermarket and the OE refurbished or remanufactured products?

Yes. So maybe I'll jump back to slide, it might help a little bit. So in North America, we're primarily once again collision. Within that collision, there is both salvage products and there's aftermarket products. That has the most biggest headwind right now. Once again, repairable claims coming down as much as they have in the last couple of years. We strive in what we -- by providing alternative parts. So alternative to the OEM, whether that's aftermarket or whether that's recycled. The benefit once again on salvage is when you produce a vehicle and you sell the collision parts, you're left with major mechanical, so engines and transmissions. That business is still strong for us, but it has some headwinds. Just if you think about an average repair of putting a used engine or a remanufactured engine is $4,000 to $5,000. So that consumer, one has to spend a lot of money to put that engine in. And two, what is my car going to be worth after I put that engine in it. And so the other piece is paint. It's wrapped up in the collision side. But when we acquired Uni-Select, you mentioned FinishMaster, that paint business we acquired, fully integrated. So today, paint is just another product line sitting on the shelf at LKQ in North America. It's not a separate business. It's a brand. But when a customer calls us today, I can provide all these different product lines out of my warehouse on the same delivery truck. The other piece that we only have in Canada today is our hard parts is that what we call Bumper to Bumper that came with the Uni-Select piece. We're leveraging a lot of our scale in Europe on buying power to get them access to product lines. And quite honestly, that was really helpful with First Brands. They're a large supplier, key brands that they have, but being able to leverage our relationships with Europe to fill in those applications as they're having some fulfillment issues, service level issues, we don't see any impact on the revenue side. They're actually a customer of ours as well. If you think about we produce 300,000 vehicles a year when we dismantle those vehicles, we produce a lot of cores, parts that we're not necessarily selling starters, alternators. We actually sell to Cardone or the brand that's within First Brands. It's not a lot of revenue. We had some exposure to that. We reserved for back in Q3. But overall, that's our business up in Canada on the Bumper to Bumper side, primarily the hard part side. But it's -- we're really leveraging our European scale to help us there.

Justin, when -- we got one here, but yes...

You're working and you have 24/7 off. And -- as you look at these companies that are appearing today, they get a multiple on their cash flow. When you're making these acquisitions, you're trying to change the culture from a core to some kind of recurring revenues so that you get a higher multiple. And when you look at a deal, is it EBITDA? Or is it the multiple that it adds to the cluster of the company? How do you view that dynamic?

Yes, great question. First off, I know he had mentioned Uni-Select. That was our largest acquisition we ever did. I was not the CEO at the time. It's -- strategically, it's a good business. But right now, especially with our -- I mean, if you guys look at our stock price, if you look at what's happening in the market, right now, we're not interested in large M&A. Any M&A that we do, and we did nothing in Q3, but it will be tuck-ins, high synergistic ones, ones that may give us key strategic abilities. But I look at higher return on invested capital over a shorter window than what we have historically. And I want to make sure that with my team out there that I'm driving accountability with, I don't want to just see what the multiple is today. I want to see the multiple after synergies, but I want to make sure that my team will deliver those synergies. So we have a higher threshold of returns on invested capital and a lower multiple when you look at all the synergies baked in. And so once again, that narrows the list down quite a bit, especially when our teams are focusing on integrating. We don't want to have more distraction. So M&A is very, very low for us.

Just one more. It's like replacing hearts. You're basically changing an engine. Do I send you my engine back and you use that as a core for further -- or what happens? So you just send a new engine out?

Great question. So we sell used engines and we sell remanufactured engines. And when we sell those engines to a lot of times, those shops don't want to get rid of -- I mean -- or they don't know how to get rid of that engine or that transmission that we do. And so we make it a great service. We'll pick that up. Many times, we'll charge them a core because to your point, we do want that back. In the world of remanufacturing core is king. So if I can bring that core back of that engine that's failed, clean it up, remanufacture it, put all new components in it, any wearable parts in it. So -- and if you look at our logistics across North America, we've got 20- to 24-foot box trucks. We're set up to deliver engines, hoods and fenders. So yes, normally, we want that engine back. Even if we're not going to remanufacture it, the scrap value that's pretty good for us, still worth for us to bring it back and recycle it.

Just as you think about your journey as CEO, you've got a business that throws off a lot of cash. You're very profitable, but you have a lot of different businesses. How do you get the Street to understand the quality of your businesses, the quality of your cash flow, where you want to go from leverage? And just so there's a clear, I would guess, disconnect between the quality of these businesses [indiscernible] afford you from a multiple standpoint?

Yes. I first have to figure out how to get guaranteed $140 million of EBITDA from the Department of War. That was pretty interesting to see that. But it's a great point. I mean I was always operational, never really involved with the investor side of it. So for the last 1.5 years, it's just a different experience for me. And I do see in talking with investors and we agree that -- I mean, we feel we're undervalued. Looking at our stock price, looking at the multiples of our businesses, we're undervalued. And a lot of that is the complexity of our business that's been -- that's gone over many, many years where we've added businesses that have different challenges, different opportunities, different headwinds and tailwinds. And so we're -- we've been inconsistent to an extent. The collision business is our primary business in North America. It's our most profitable business. That's been under headwinds with repairable claims continuing to be on the decline. So as a company, we've just been kind of inconsistent. So for me to simplify the operations, for me to simplify the portfolio, allowing our teams to focus more importantly because to your point, we do generate strong free cash flow, and we will continue to generate strong free cash flow. We think, once again, we're a great buy. We're undervalued. But we still need to continue to make sure we simplify the portfolio, prevent it from getting more complex, right? So when I talk about restricting acquisitions, we're head strong on restricting those, making sure they're strategic, making sure they fit in the long-term core operations that we have. But just continue, we've got to execute. We got to say what we're going to do and then we got to deliver.

Justin, could you give us an update as to the North American business relative to tariffs? Obviously, there's been some refreshing on the tariff information. And are you able to pass through all of the costs that you're assuming as the importer?

Yes. So the most recent news of executive order, we think, is a benefit when it talks about repair parts. But if you think -- if you understand how things work in government affairs, the executive order comes through, it's got to go through multiple layers until it gets in a language that we can actually then go to customs and say, this is what we can do. Long term, we think that new executive order is a benefit to us. The previous tariffs or the tariffs that are technically still in existence, we've been able to pass those on dollar for dollar, [ Bret ]. We've struggled on making sure -- and this is really North America aftermarket collision parts, right? Our used parts, our paint really doesn't have tariffs, so it's aftermarket collision parts. And when I compete in the aftermarket collision parts world, I compete with 2 different people. I compete with pure aftermarket distributors that sell the same product lines, and I compete with the OEM side. And in some cases, the OEM had different tariff charges than what we did if they produce in Mexico and we have ours produced in Taiwan. So we've been able to, from a pricing standpoint, make sure that we stay in between our pure aftermarket competitors and our OEM. we have a better fill rate, better service levels. So we always strive for higher value than our competitors. But on the OEM side, we need to have that value proposition for the insurance company. And we've had mid-teens savings still even as we pass on the tariffs. Historically, we've always been able to make margin on top of those tariffs. We haven't necessarily made those margins on top of the tariff because we don't -- we just want to make sure we don't get too close to OEMs. We still want those savings. But dollar for dollar, we have passed on all the tariff price increases that we've seen.

In the Specialty business, I'm curious about what you guys are seeing on the accessory side of things. Obviously, OEMs are prioritizing pickup trucks and SUVs and some of those higher dollar vehicle categories. But I'm curious if you're seeing any shifts in like consumer discretionary behavior and spending on the accessory side.

Yes. Unfortunately, we haven't seen the market rebound yet. Our specialty business is split roughly 50% SEMA-type product, accessories, specialty and the other 50% is RV. So both of those still have some pressure. They're not -- I don't want to say they're on the decline, but they're not necessarily rebounding yet. We had great growth in Q3. One thing we've done across our business is any time we've had these economic headwinds, we don't want to sacrifice fill rates. We didn't want to sacrifice service levels. And so we had some share gains in Q3. And so our revenue grew 9.4%. That was not underlying market for us. That was just share gains, getting a little bit more share of wallet from some of our existing customers and some of our new customers. But long term, you're right, the OEs are focusing on truck [indiscernible] and jeeps and SUVs. That's our bread and butter when it comes to SEMA product lines. If we see more movement with not just new RV sales, but RV utilization, that will then help the other portion of our business. But both businesses show growth for us, both the SEMA in Specialty space and the RV.

Can you comment on repairable claim trends in Europe?

Yes. So we are very small on when it comes to collision in Europe. However, they have some of the same challenges. It's not as publicized. Some of the data is not easy to get by countries as it is in the U.S. But we're in the U.K., where the largest collision business we have is in the U.K. today. We work with a lot of insurance carriers. We've primarily been up until about 3 months ago an aftermarket competitor or an aftermarket distributor of parts and paint. We now did a joint venture with Ritchie Bros and that SYNETIQ where we are going to be offering salvage now as well. And so we're very close with -- working with insurance companies who are seeing that demand in repairable claims come down. They're seeing the same thing that we are in the U.S. where people are driving uninsured or liability only. And so we think that headwind will be there for -- until some of these things change. And I don't want to predict when they're going to change, but at some point, I feel they will change. But we see collision as a big opportunity across Europe because 2 reasons. One, it's underutilized today. There's really no big competitors that provide -- other than OEMs that provide these types of product lines. Two, alternative parts utilization is relatively low in Europe. It always has been. The overall APU, the alternative parts industry doesn't really exist at the scale that it does in North America. And so when we bring our existing technology, our existing distribution and we add collision parts into it, we feel that we can help drive APU expansion. So not only will the market recover in collision in Europe, we continue to gain share. But in addition, we think the overall piece of that pie is going to get bigger as APU grows in Europe.

A couple of quick ones over here. As you look at APU in North America, how do you think through -- is there a ceiling to APU? Where can APU go just given all the cost pressures that the industry is seeing? And then maybe take that a step further, as you get incremental APU penetration or even just see claims, repairable claims bounce off of the bottom, walk us through sort of the incremental operating leverage in the North American business?

So I'll take the first question. I'm going to let my CFO speak just he hasn't spoken at all today so far. So on the APU side, we do see a benefit of the pressure that the insurance carriers are under that you kind of mentioned, a lot of share loss between the carriers have occurred. So you're starting to see them hold prices down, especially on new customers. That's driving -- and look, they're still seeing inflation. They're still seeing part price increases. They're still seeing inflationary pressure on labor. And so if they have to lower their premiums of what they're charging to consumers and they want to remain profitable, how do they do that? They're going to try to use more alternative parts utilization. And so APU for the third quarter was right at 38%. It was flat quarter-to-quarter. It was up about 150 bps year-over-year. We have some carriers that, quite honestly, are in the low 30s. We have some carriers that are in the low 40s. So if every carrier went to compete with the highest utilization, you see low to mid-40s on that. It will never be 100%. There's product lines that don't have the volume to produce aftermarket or insurance companies may not ever write used airbags or aftermarket airbags or some of those product lines. But looking at what some insurance carriers do today, I see that number to be able to grow to the low to mid-40s. And then from a leverage standpoint, as that volume rebounds, Rick what you think about that?

On the leverage side of it, we saw some pretty significant deleveraging. We're down to around 14% EBITDA in Q3. And the business when we acquired Uni-Select, I talked about being around 17% on a steady state ongoing. There's 2 big things that have happened since Uni-Select. One is the tariffs. That hurts us for about 40 basis points. So that will bring that number down because we're only getting dollar for dollar. And then the other thing that impacts us is the significant change in MSOs. So the MSO as a percentage of our overall business as the markets come down, we've gotten a lot more MSO volume. So there's about another 30 basis points there. So call it somewhere in the low 16s is where a steady state number should be when the volumes start returning, right? So -- as you think about a 14% number, as the volumes start recovering, we should be able to see a pretty decent snapback relatively quickly. And then I think the more steady-state percentage is probably closer to that 16% because of those 2 items. But nothing materially has changed in the business from what we talked about a couple of years ago.

Unfortunately, we are bumping up on time, but Justin, Rick, really do appreciate you guys coming and hope to see you guys next year.

Thank you. Appreciate it, guys.

Justin, thank you.