Tuesday, January 17, 2006

Keystone Automotive

Keystone Automotive Industries (KEYS) has been upgraded by several brokers in the last few weeks, including an upgrade to a Buy last night.

The company is a leading distributor of aftermarket collision replacement parts which are produced by independent manufacturers (mostly in Asia) for automobiles and light trucks. The company essentially sells auto body parts i.e. fenders and bumpers made in Taiwan as a replacement for parts damaged in a collision. The company is primarily a distributor; though it does do some wheel remanufacturing (repairing damaged wheels) as well as steel bumper recycling. The distribution system consists of many small locations numbering currently 129 distribution centers (22 of which serve as regional hubs) 38 states throughout the United States and Canada. The company acquired a competitor in New England recently.

Insurance companies love using alternative parts supplied by companies like KEYS. They are much cheaper than what replacement auto parts purchased directly from the auto manufacturers cost. In many cases, they are made in exactly the same plants. But consumers have protested the substitution of alternative parts for the “real thing.” In fact, a lawsuit that embattled State Farm for 6 years was decided by the IL Supreme Court in August of 2005 which found in State Farm’s favor, and consequently should benefit KEYS. However, this decision is still pending appeal.

The company has generally been a free cash flow generator, but recent trends suggest some changes here. CFFO for the YTD has been less than net earnings, reporting CFFO of only $2.3 million versus the $4.7 million in reported net income. The comparable figures for last year were only $3.5 million in net income but $9 million in CFFO. Free cash flow YTD is only $1.1 million versus $5.9 million in last year’s comparable period.

The stock is currently trading around $34, up over 60% versus a year ago when the stock was $21.

Wall Street analysts expect earnings growth of 19.5% versus what I calculate as a sustainable growth rate of about 8.5%. EV/EBIT is about 23.5 times and ROIC is only about 8% for the last twelve months stats. The company pays no dividend and has not bought back any stock since 2001, in fact issuing about $16 million in stock in the last five years.

Free cash flow in the last five years has totaled about $37 million but none of it seemed to find its way back to shareholders as dividend or buyback. Returns on capital have not been that spectacular recently either …back in the late 90’s the company used to be a 12-15% ROIC company, post 2000, it has averaged 8.7%. By way of contrast, Cardinal Health (CAH) a drug distributor has averaged 14% ROIC in the last five years, 75% higher than KEYS and sells at an EV/EBIT of about 17 times, or about 30% less.

The FCF margin for the last twelve months is less than 1%. The FCF yield at current prices is also less than 1%.

I was somewhat encouraged when I looked at insider sales and their relative inactivity. The CEO has actually accumulated some stock, having made open market purchases, and holding about 62,000 shares. However, just about all other officers aren’t shareholders:

John Palumbo, the CFO, doesn’t own a share.
James Lockwood, vice-president…no stock
George Seebart, director………..nada
Jesus Arriaga, CIO…..no stock

I can’t expect to see insider sales, when most of them have already sold!

This is a distribution company with a fairly neat niche holding over 20% of its market. Litigation against the auto insurance companies may have cooled but still could be appealed. The free cash flow characteristics of this business do not appear to be what they had been. Returns on capital are okay but not spectacular and certainly not where they were. Returns of capital to shareholders are non-existent…no dividend, no buybacks since 2001. Wall Street growth estimates seem very high relative to what the company has historically achieved.

In my view, the price seems to have incorporated a lot of these robust expectations.


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