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LKQ Sees a Tougher Year Ahead

Dan Caplinger, The Motley Fool

It's always difficult to predict exactly how certain specialized sectors of the economy will respond to changing conditions. For auto parts maker LKQ (NASDAQ: LKQ), an international scope to its business has caused some downward pressure on growth, because economic conditions in Europe have been challenging for quite a while. In response, LKQ has worked to try to make its operations more efficient to squeeze more profit from its revenue.

Coming into Thursday's second-quarter financial report, LKQ investors hoped that the auto parts company would be able to deliver solid if modest levels of growth. LKQ's bottom-line performance was better than many had expected, but weaker sales led the company to cut back on its guidance for the full 2019 year.

Composite of dozens of auto parts, including wheels and hubcaps, lights, and cleaning and detail products.

Image source: LKQ.

LKQ deals with difficult conditions

LKQ's second-quarter results were mixed in the eyes of many. Revenue climbed 7.2% to $3.25 billion, and that was only half the growth rate that LKQ managed in the first quarter and fell short of the $3.29 billion that most of those following the stock were expecting. Adjusted net income picked up 6.3% to $204 million, and the resulting adjusted earnings of $0.65 per share topped the consensus forecast among investors by $0.01 per share.

However, LKQ's revenue figures incorporate a substantial impact from recent acquisitions. In the key parts and services segment, organic revenue actually fell 2.1% year over year, and it took a 12.6 percentage point upward boost from acquisitions to overcome both that headwind and the 2.5 percentage point hit that the company suffered from the strong U.S. dollar in comparison to foreign currencies. In addition, LKQ's net income from continuing operations was down 4% from the year-ago period, with an impairment charge weighing on the auto parts maker's bottom line.

There were some noteworthy trends across LKQ's business. In the parts and services segment, North American sales were just about flat, and specialty parts actually saw a slight decline in revenue. European growth of 18% once again resulted from acquisition-led expansion, as organic revenue in Europe fell 4.3%. LKQ also saw weakness in its other business segment, with a 7% drop in revenue dragging down the company's overall business.

However, in measuring segment adjusted pre-tax operating earnings, LKQ fared much better. Both North America and Europe saw gains in adjusted pre-tax operating earnings from its parts and services business, with only the specialty parts segment seeing a drop in segment profitability by that metric.

What's ahead for LKQ?

CEO Dominick Zarcone tried to put those numbers in a positive light. "We continued to make progress on our key productivity initiatives during the second quarter," Zarcone said, "notwithstanding difficult revenue growth comparisons across all of our operating segments, a soft collision environment in the U.S., and the ongoing macroeconomic challenges and the impact of one less selling day in Europe." The CEO also noted that operating margins rose substantially to reach their highest level in two years during the period.

However, the changes that LKQ made to its guidance didn't reflect the optimism that investors wanted to see. The company cut its range for expected organic revenue growth in parts and services for the full 2019 year by 1.5 to 2 percentage points to 0.5% to 2%, and more substantial cuts in expected adjusted net income delivered a $14 million to $28 million hit, setting a new range of $718 million to $743 million. That resulted in a reduction of $0.04 to $0.08 per share in adjusted earnings guidance to a new range of $2.30 to $2.38 per share.

Shareholders in LKQ didn't respond quickly to the news, with the stock remaining unchanged in premarket trading following the announcement. However, if tough times economically keep affecting LKQ's future business, then investors might have to be more patient than they'd like before they'll see the auto parts company live up to its full potential.

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Dan Caplinger has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends LKQ. The Motley Fool has a disclosure policy.