How to Invest in Junk (Without Buying Risky Bonds)

A handy fellow can still pick his own car parts at the local salvage yard.

Meanwhile, the rest of us pay a markup for parts and service because we have neither the inclination nor the time to hunt down that gently used bumper, paint it and rig it to the family van. Ironically, many of the parts installed by professionals come from the same junkyards.

But today’s salvage business is not your grandfather’s pick-your-own-parts shop for shade tree mechanics. The market for recycled automobile parts has consolidated as bigger firms service a multibillion-dollar industry with tens of thousands of customers in auto insurance, collision repair, mechanical repair and scrap recycling.

Recycled parts can sell for -20% to -50% less than the original equipment manufacturer (OEM) parts, which is a big reason many automobile insurers are bullish on recycled parts. Each year, about 11 million cars are recycled by salvage yards. It’s a truly sustainable industry that doesn’t get a lot of recognition for being green.

LKQ Corp. Corporation (Nasdaq: LKQX) is the leader in the market for recycled and aftermarket parts – also known as alternative parts – used in the $30 billion collision-repair industry. While the service departments at most major dealerships use new OEM parts for replacement, there are many more independent collision-repair shops – at least 32,000 – that are open to using recycled OEM and aftermarket parts.

Chicago-based LKQ Corp. became the largest provider of alternative parts by consolidating many of the country’s mom-and-pop salvage yards during the past decade. After dismantling salvage vehicles, LKQ salvage yards will inventory fenders, doors, quarter panels, bumpers, hoods and light housings for sale to repair shops.

The alternative parts industry is usually unaffected by economic downturns. However, LKQ’s growth slowed during the recent recession in response to fewer insurance claims and the tendency of motorists to use settlement checks for bills instead of repairing dented vehicles.

LKQ is projecting 2009 organic revenue growth at a rate of +6% to +8%, compared with +8.8% for 2008. Net income in 2009 is projected to be about $120 million, compared with $99.9 million in 2008. Joseph M. Holsten, CEO and president of LKQ Corp., has attributed earnings to growth in its same store aftermarket sales, and an improved inventory management system.

Before consolidation, regional repair shops had limited options for finding quality recycled and aftermarket parts. If the salvage yard in town didn’t have it, the repair shop often had no choice but to purchase the new, more expensive part from manufacturers.

Now, if a local LKQ yard doesn’t have the part, its employees can try to track it down through the company’s vast network. The company has an even better chance of finding replacement parts since it began selling aftermarket parts in 2004.

New OEM account for 68% of parts used in the collision-repair industry, while alternative parts make up 32%. Alternatives can be controversial, though. Repair shops at major dealerships prefer new OEM parts, but the aftermarket industry is making strides in quality control with limited warranties and certified parts.

LKQ hopes healthier economic conditions in 2010 will provide motorists – who might still be too cautious to purchase new vehicles – with extra cash to replace those dented bumpers and quarter panels on currently owned cars.

And LKQ Corp. is moving ahead with its ambitious consolidation plans. The company recently acquired Greenleaf Auto Recyclers, a wholesale recycling business with about $114 million in annual revenue. It also acquired Green Superior Collision Parts, an aftermarket supplier with $11 million in revenue.

If you’re looking to add a different shade of green to your portfolio, you’ll want to consider LKQ.