Stock Analysis

LKQ (NASDAQ:LKQ) Seems To Use Debt Quite Sensibly

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NasdaqGS:LKQ
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David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies LKQ Corporation (NASDAQ:LKQ) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for LKQ

What Is LKQ's Net Debt?

As you can see below, LKQ had US$2.31b of debt, at June 2022, which is about the same as the year before. You can click the chart for greater detail. However, it does have US$265.0m in cash offsetting this, leading to net debt of about US$2.05b.

debt-equity-history-analysis
NasdaqGS:LKQ Debt to Equity History August 15th 2022

A Look At LKQ's Liabilities

Zooming in on the latest balance sheet data, we can see that LKQ had liabilities of US$2.49b due within 12 months and liabilities of US$4.02b due beyond that. Offsetting this, it had US$265.0m in cash and US$1.16b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$5.08b.

LKQ has a very large market capitalization of US$15.4b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

LKQ's net debt is only 1.2 times its EBITDA. And its EBIT easily covers its interest expense, being 24.1 times the size. So we're pretty relaxed about its super-conservative use of debt. LKQ's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine LKQ's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, LKQ generated free cash flow amounting to a very robust 87% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

Happily, LKQ's impressive interest cover implies it has the upper hand on its debt. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! Taking all this data into account, it seems to us that LKQ takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for LKQ you should be aware of, and 1 of them is significant.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

What are the risks and opportunities for LKQ?

LKQ Corporation distributes replacement parts, components, and systems used in the repair and maintenance of vehicles.

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Rewards

  • Trading at 21.6% below our estimate of its fair value

  • Earnings grew by 14.5% over the past year

Risks

  • Earnings are forecast to decline by an average of 0.9% per year for the next 3 years

  • Has a high level of debt

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About NasdaqGS:LKQ

LKQ

LKQ Corporation distributes replacement parts, components, and systems used in the repair and maintenance of vehicles.

The Snowflake is a visual investment summary with the score of each axis being calculated by 6 checks in 5 areas.

Analysis AreaScore (0-6)
Valuation4
Future Growth0
Past Performance5
Financial Health5
Dividends3

Read more about these checks in the individual report sections or in our analysis model.

Excellent balance sheet with solid track record.