Collision sector posts strong Q3 numbers: ‘Effects of crash avoidance systems overblown,’ says analyst

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By Jeff Sanford

Toronto, Ontario — November 2, 2015 — It’s earnings season again. Companies in the collision repair sector are reporting extremely solid results.

Quebec-based Uni-Select announced that it managed to ring up a strong $276.2 million in sales. This is up 4.0 percent from the same period last year. Earnings (on an EBITDA basis) provided a 9 percent margin on invested capital. Net earnings were up 6.1 percent to $15.7 million. This resulted in earnings per share of $0.73, an increase of 4.3 percent over the same period last year. Converting the earnings back to Canadian dollars sees earnings per share boosted 18.8 percent this period.

“I am very pleased with the performance displayed by our automotive and paint and related products businesses in the third quarter and particularly delighted that both sectors are delivering healthy organic growth,” said Henry Buckley, President and Chief Executive Officer of Uni-Select.” We now turn to the fourth quarter with confidence that our continued focus on growth initiatives, accretive acquisitions and our commitment to the continued expansion of a network of corporate stores will all contribute to our successes in the months ahead.”

Also reporting strong numbers this week is LKQ, the auto recycler and parts distributor. The company enjoyed strong growth both organically and through acquisitions, as well as through “wider consumer acceptance of alternative parts,” according to a report published by Mark Kusnir on the popular financial website seekingalpha.com. Lower prices for scrap steel and a high American dollar did not prove to be the headwinds that would prevent growth in earnings (as some thought might be the case).

But the most interesting part of Kusnir’s analysis is his claim that “fears that crash avoidance systems could weight on companies in the sector are overblown.”

Kusnir wonders if some investors are concerned by a recent pledge by big auto manufacturers that crash avoidance systems will become standard on new vehicles. The analyst points out that LKQ shares have dropped 5 percent since the last earnings call. The downward drift can be partly explained by the pledge made on September 11 of this year by ten automakers “… to make automatic emergency breaking (AEB) a standard feature on future vehicles. The analyst went on to explain why AEB is not a factor to be concerned about.

“LKQ is well aware of the threat … there are a number of reasons they’re not too concerned and investors shouldn’t be worried either,” says Kusnir. “First, a timeline for implementation of AEBs has not been set. Second, these systems are not 100 percent reliable. Most of the time, these systems don’t prevent a crash but only lessen the impact of a crash. Even if crashes are lighter, new fenders, bumpers, and hoods are still needed. LKQ will still provide them.”

This means these new systems may help to reduce overall severity. This could potentially lead to fewer totals and more repairable vehicles.

Kusnir also points out that the the adoption of these systems will be slow.

“The ten pledging automakers only account for 57 percent of light duty vehicles. Even in ten years, most cars on the road will be without AEB as the average car life continues to increase. The company expects less than 10 percent fallout over the next 35 years. The company isn’t going to disappear,” according to Kusnir. “Don’t be scared away by driverless cars or other collision prevention technologies; the future remains bright. Instead, focus on the company’s ability to efficiently integrate acquisitions and grow organically. The track record is clear. LKQ continues growing revenue and earnings despite strong currency and scrap price headwinds.”

LKQ reported revenue of $1.83 billion, up 6.4 percent from last year. Organic growth was 6.8 percent. Almost two-thirds of that growth came from wholesale operations. This is important to note, according to Kusnir. The strong increase in wholesale numbers “means consumers are willing to pay for a lower cost non-OEM, non-new part as a replacement collision part. This is a great sign that the company is proving the value of their business model,” says Kusnir. The company purchased seven companies in the United States and Europe this quarter, bringing the 2015 total to 17. So growth is happening through acquisitions as well.

“Consolidation is consistent with their strategy and they’ve had success raising the operating margins of their acquisitions in the past. Expect the company to continue purchasing profitable growth,” according to Kusnir.

The “alternative collision parts supplier,” has become “a reliable growth machine,” he says. Using an analysis system derived from the work of legendary investor Benjamin Graham (hero of Warren Buffett), Kusnir calculates a fair price for the stock based on earnings. According to this methodology LKQ shares are actually trading 30 percent below what they should be trading at.

Another analyst who likes LKQ is William Blair & Company’s Nate Brochmann. He released a report on the latest numbers making that same claim, that LKQ shares remain undervalued. “… long-term opportunity remains attractive … the increase in new car production should turn from a headwind to a tailwind as those cars get out of warranty. Also, LKQ is starting some e-commerce business, which is aimed at attracting some do-it-yourself and do-it-for-me customers and is showing some cost benefits from self-pickup,” wrote Brochmann in the report.

He also likes the fact that the average number of miles driven by Americans continues to increase. “The 12-month moving average for miles driven through July 2015 reached its highest level (up 3.4 percent) since 1990. Underlying drivers remain positive with lower unemployment rates and fuel prices. This increase in miles driven has likely contributed to the higher accident rates recently, along with increased distractions in the car. He also points to the increase in new car production as a reason to like the stock.

“The [production] rate for the third quarter was up 6.1 percent, to 17.8 million units. This will likely be a modest initial headwind until the cars come off warranty; however, it will help accelerate growth once these cars enter the company’s sweet spot of three to nine years old,” he says.

Brochmann also points out that there are more parts per repair than in days past, and this is also helping earnings.

“New cars now have more parts, which equates to more parts per repair,” he writes. Costs per-part are also increasing. “As the cost per part increases with new technology, insurance claims also inflate, which makes cheaper alternative parts more attractive to insurance companies,” according to Brochmann.


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