LKQ, Copart and Schnitzer Steel (owner of 53 Pick-n-Pull salvage auto parts outlets) are in the same industry, basically doing the same thing, with minor differences.
LKQ (LKQ) buys old and wrecked cars from car owners and insurance companies (3 to 9 years old vehicles), dismantle them, some of which will be sold as used parts, and some as scrap mettle.
Copart (CPRT) buys damaged cars mainly from insurance companies and sell them to both foreign and national entities via an online auction.
Schnitzer Steel (SCHN) generates most of its revenue from steel and recycle scrap metal, but has a decent business selling used auto parts.
Here is a comparison of their financial performance using our checklist.
|1||Working Capital Ratio (current assets / current liability) > 2||3.1||1.91||2.82|
|2||Positive Net Tangle Assets (total assets – goodwill – intangibles – total liability)||698M||453M||339m|
|3||Price / book (price per share / book per share) < 1.5||12.6||9.2||1.26|
|4||Price / Earnings (price per share / earnings or net income per share ) < 20||21||22.69||N/A|
|5||Positive free cash flow in the last (3) years (operational profit – capital expenditure)||309M||147M||54.5M|
|6||Free Cash flow yield (free cash flow / market capitalization) > 15%||3.50%||3.00%||12.60%|
|7||Return on assets (net income / total assets) > 10%||7.40%||16.50%||N/A|
|8||Interest coverage (Income before interest and taxes EBIT / interest payments) > 7||12.17||19||N/A|
|9||Debt to Free Cash Flow (long term liability / free cash flow) < 5||4.9||3.9||4.2|
|10||Debt to Equity (long term liability / shareholders equity) < 50%||49.00%||79.00%||42.50%|
|11||Dividend yield > 2%||N/A||N/A||4.36|
|12||ROIC (net income – dividends / total capital) > 15%||7.40%||N/A|
|13||Gross margin increase for the last three years||N/A||+200 bp||+90 bp|
From the table above LKQ’s BIG positives are its 3.1 working capital ratio, its interest coverage and debt to equity ratio.
Copart’s BIG positives are its return on assets ratio, interest coverage, debt to free cash flow ratio, gross margin increase and ROIC
Schnitzer Steel’s advantages are its working capital ratio, is price to book ratio, it free cash flow yield, its debt to equity ratio and its dividend yield.
From a conservative investor standpoint, SCHN has more positives than its peers, except for the fact that steel prices are at all time low and the company is not generating a profit at this time. With a decent profit and $16.24 stock price, it would be a BUY
A BIG thanks to those of you who made it to the class (sharing session). I anxiously look forward to seeing all of you at the next class. Although it was a small class, we take comfort in the words of Zechariah 4:10, “Do not despise these small beginnings, for the Lord rejoices to see the work begin, to see the plumb line in Zerubbabel’s hand.”
We basically went over what a CHECKLIST is and we started to dissect the books of LQK Corp. Why LQK you may ask? Well, must of the guys in the class seemed to be associated, whether through vocation or interest, in the automobile industry.
Now on the subject of a checklist. Teachers on the first day of school have a checklist; doctors on the cusp of performing an operation have a checklist; builders commissioned to build a house have a checklist; therefore, it should be considered both prudent and practical that to arrive at a wise and profitable investment decision a checklist is indispensable.
Christ said, “If any man is to build a house, will he not sit down and calculate the cost” (Luke 14:28). A checklist is a guiding light pointing you to the needle in the haystack; a checklist is a winnowing folk to help you clear the threshing floor, and separate the wheat from the chaff. Let your positive feelings about a company not be aided by emotions, but be abetted by sound analysis and the conclusion of a perceptive mind.
Before we dive deep into the interior of 7 Fat Cows Checklist, let us have a brief overview of the fundamentals of a stock.
So what is a stock? A stock is a financial instrument that represents your partial ownership in a company. Yes, ownership – such a wonderful word.
There are only two ways companies can raise capital. They can do so with debt, borrowing money from banks, or they can achieve that end through equity, selling shares of the company to you and me – the public.
When a company goes public it authorizes a number of shares and issues a fraction of those shares to be sold to the public. For instance, LKQ has 1,000,000,000 shares authorized, and 303,452,655 shares outstanding as of December 31, 2015 (see page 63 of its annual report). The number of shares vary between the authorized shares and outstanding shares can be sold to the public at a future date at the discretion of the board of directors, and in some cases, subject to the vote of the shareholders. This is done, in many instances, to raise additional capital for mergers and acquisitions, business expansion, fixed expenses (CAPEX), etc. At times, when financial expediency prevails, corporations will buy back their shares from the public. We will dive deeper into this concept of buy-backs in our next class dealing with Free Cash Flow (FCF).
Now, if you take the shares outstanding (all the shares owned by current shareholders) 303,452,655 and multiply that by its current price ($28.16) you arrive at a market capitalization or market cap of $8.6 billion. Interestingly, LKQ price has levitated from $25.91 a share to $28.16 a share, an 8.9 percent gain from the time of our first class a few days ago. What event has transpired to engender such appreciative moment in price? The company reported its 4th quarter and full year 2015 results on Thursday and the numbers were above Wall-street expectations.
As a shareholder of any corporation, you have tremendous weight in the direction of the enterprise. Normally each share means one vote and an astute shareholder should not negate his/her fiduciary duties. You are the owner of the corporation, the executives are the employees. Therefore, as a shareholder, it behooves you to read up on your company and vote at your company’s annual meeting of shareholders (whether by proxy of in person).
While we are on the subject of reading, the average American watches 5 hours of television a day. What if you were to watch television only 4 hours a day and spend one hour in a worthy cause – in reading financial reports and studying how companies work? Do just that and in five years you will be an expert on the financial markets and a person with all the faculties of a business wizard.
Wow! That would be an accomplishment.
Motivational speaker and writer Jim Rohm said, “Make a million dollars, not for the money, but for the person you would have become in the process of making a million dollars.”
Speaking of reading, Warren Buffet published his annual letter to shareholders today. Please read it. If you want to be a great philanthropist, read the words of Mother Theresa; if you desire to become a great evangelist, read about Paul; if you cherish the hope of investing wisely, read the words of Warren Buffet.
Working Capital Ratio (current assets / current liability) > 2
Current assets 2,340,712
Current liability 751,970
Positive Net Tangle Assets (total assets – goodwill – intangibles – total liability)
Total assets 5,647,837,000
Goodwill – 2,319,246,000
Intangible assets – 215,117,000
Total liability – 2,533,155,000
A preferable matrix than NET Tangible Assets is Net current Assets (current assets – total liability)
Current Assets 2,340,712,000
– Total liability 2,533,155,000
Net Tangible assets = $580,319,000
Price / book (price per share / book per share) > 1.5
Book Value per share ($580,319,000 / 303,452,655) = $1.90
P/B = $28.16 / $1.90 = 14.82; meaning for every dollar ($1.00) of assets the investor will be paying $14.82
Price / Earnings (price per share / earnings or net income per share ) < 20
Currently it is 21.15
Positive free cash flow for the last three years (operational profit – capital expenditure or expense of fixed assets)
Free Cash flow yield (free cash flow / market capitalization) > 15%
Free cash flow FCF (Net cash from operating activities – Capital expenditures or Purchases of property and equipment)
Average FCF for the last three years: $309m
Yield: $309m / $8.6b = 3.6%
Return on assets (net income / total assets) > 10%
$4.2m / $5.65m = 7.5%
Interest coverage (Interest before interest and taxes EBIT / interest payments) > 7
$705m / $58m = 12 times
Debt to Free Cash Flow (long term liability / free cash flow) < 5
$1.53b / $309m = 4.95
Debt to Equity (long term liability / shareholders equity) < 50%
$1.53b / $3.1b = 0.49
Dividend yield > 2%
Pays no dividends
Gross margin increase for the last three years
Gross margin / total revenue for the last three years
2013 – 41%
2014 – 39.3%
2015 – 39.4%
A one percent reduction in gross margin is equal to $72m. From 2013 to 2014 the company experience a reduction in gross margin of 1.6 percent or about $115m
Please view the video, follow the instructions, print and read the latest annual report of LKQ. We will discuss more granular data in next class.