AGB 2021.25 - Copart (CPRT)
Reducing Friction for Auto Salvage
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Copart is not the most complex business but it seems like there’s something new to learn about the company every quarter. Part of that likely has to do with management’s reluctance to divulge KPIs consistently (the latest and only investor presentation available is from April 2016). If you want to get a feel for the history of the company, Willis Johnson’s autobiography “Junk to Gold” is worth a read. Also, this Forbes article from November 2020 has a nice update to what’s going on operationally at the company.
Copart is a leading remarketer of salvaged vehicles in the U.S. and around the world. The company operates a network of salvage yards (10k+ acres) used to store vehicles before they are put up for auction on Copart’s online bidding platform called VB3. According to the company’s website, Copart has 265k+ cars available daily for auction stored at their 200+ salvage yards and sells 3M+ vehicles each year to buyers from 190+ countries.
Copart’s main source for supply of salvaged vehicles (typically ~80%) are from insurance companies that have declared a policy holder’s vehicle a total loss after an accident. The remaining 20% comes from non-franchise auto dealers, finance companies, rental car companies and charities. The non-insurance cars are more likely to be whole car auctions rather than salvage, so the turn around time is quicker.
In the U.S., when a car is severely damaged in an accident, it’s typically towed to a storage facility or a collision repair shop where it can then be inspected by an adjuster from the policy holder’s insurance company. The adjuster estimates the costs for repair and the insurance company determines whether to pay for repairs or to classify the car as a total loss and write the policy holder a check.
The general decision making framework is if the cost of repair + the cost to provide a rental car is more than the pre-accident value (PAV) of the car – the estimated salvage value, then the insurance company will declare the vehicle as a total loss. If the car is declared a total loss, the car is towed to the nearest Copart salvage yard, where it can be stored until it’s put up for auction. The title needs to be cleared with the local DMV and converted into a salvage title prior to being sold and this part of the process can be long. The average salvaged vehicle can sit in a yard for 45-60 days.
Then the vehicle is put up for auction where buyers from around the world can bid to purchase the car. Copart makes sure that the vehicle is ready for auction and takes the necessary photos and information so that the buyers can know exactly the condition and state of the vehicle they are purchasing. Auctions of insurance company owned vehicles are generally on consignment, meaning Copart doesn’t take ownership of the car at any time in the auction process. Copart just gets a fee for the services that the company provides.
Buyers are vehicle dismantlers that sell off the valuable parts, rebuilders, used car dealers and exporters that repair the vehicle to drivable standards in their countries (standards are usually lower in other parts of the world). The company’s auctions attract 750k+ buyers in over 190+ countries. Of the international countries, Mexico is the largest buyer due to the proximity to the U.S. (7% sales in FY16 Q2), followed by the UAE, Nigeria and Jordan. International buyers as a collective purchase roughly 35% of the units sold through the online platform, but represent almost 50% of the value transacted on the platform. The company estimates that international buyers impact 90% of the bidding activity on the platform.
Insurance companies choose to work with Copart because the returns on salvage make sense economically. Every insurance company is different but typically the insurance company will go through some type of decision-making process when deciding to salvage a car. Copart helps many of its insurance partners to accurately estimate the salvage value of a car on the company’s auction platform through its ProQuote software offering. Leveraging Copart’s database of completed auctions, the company aims to accurately predict what the salvage value would be depending on the different variables specific to the car. This product has been refined over the years and continues to be improved with each new version.
Insurance companies also work with Copart for catastrophic events like hurricanes that can cause damage a large number of insured cars in a short period of time. Typically, all of these cars will go into salvage because they are damaged beyond repair and there wouldn’t be enough repair shops available to fix them in a timely manner. Copart takes these cars to their salvage yards or to temporary storage locations (that Copart pays rent for) and lightly repairs them for auction.
The company has stated that these catastrophic events usually suppress gross margins because (1) the costs of transporting the vehicles to the various yards are paid upfront and not recouped until the auction sale has been made and (2) because the company has to bring workers in from other parts of the country to man the operations related to the surge in inventory. Copart also needs to acquire more equipment to operate the temporary storage locations. For Hurricane Harvey, the company lost $8.2M on the event given the high cost for temporary storage and increased operating costs.
Copart’s largest competitor is IAA, which combined with Copart command more than 80% market share in the U.S. IAA and Copart have many overlapping insurance partners though Copart has been taking share in recent years. Each company competes based on the returns for salvaged vehicles on their respective auction platforms and the level of customer services provided to the insurance partners during catastrophic events.
The demand drivers for Copart are nicely laid out in the company’s investor presentation from April 2016. The key drivers are Miles Driven x Accident Rate/Miles x Salvage Rates. More miles driven means more accidents, assuming that the accident/mile ratio remains constant. The largest demand driver over the past 5 years has been the growth in the salvage rate. This is discussed in the following section.
Why is it a good business?
Copart’s business benefits from network effects and scale economies. The network effects are related to the company’s auction platform, which materially improved when the company switched to digital auctions in 2003. As the company gets more supply on the platform from its partnerships with the various regional and national insurance carriers, more buyers are attracted to the platform. And as more transactions occur on the platform liquidity increases.
Each auction only results in one buyer, but more bidding activity means that sellers on average are able to achieve higher winning bids. And sellers will generally want to transact on the platform which results in the highest ROI, which is partly due to the number of buyers (especially international buyers) and the usability of the platform including discovery, pricing, information and picture availability, etc. Buyers are naturally attracted to platforms that have more supply of salvaged vehicles as long as the pricing makes sense.
Copart’s scale economies are the result of the 200+ salvage yard locations in the U.S. and internationally. To meet demand, Copart has been aggressively increasing the number of new yards and the company looks to purchase land for its salvage yards based on size, availability and proximity to its other salvage yards. This is because average transportation costs and towing time are lowered for each incremental salvage yard within a region. As these costs go down, Copart can then reinvest that back into the business to further increase the company’s scale.
The barriers to competition for this business is from the salvage yards themselves. It’s difficult to procure new salvage yards as the vehicles stored on these yards can leak hazardous materials and chemicals into the ground. It’s especially difficult in densely populated areas and not cost efficient. Copart has mentioned that the company wasn’t able to find a new salvage yard location in Los Angeles for decades until FY17. For a new entrant to compete with Copart and IAA, they would need to build and acquire a network of new salvage yards across a region to win contracts with the various national and regional insurance companies. And given that 80% of the industry’s volume is sourced from insurance companies, it’s almost impossible for a new entrant to get to scale.
There are many industry tailwinds that have benefited Copart over the past 10+ years. The first is that the percentage of auto accident claims that are deemed a total loss have gone up from 14% in 2013 to over 20% in 2020. There are two main reasons for this trend and Copart believes that the metric will continue to move higher long-term.
The first is that the cost of auto repair has gone up due to (1) consolidation of collision repair shops, and (2) the increasing complexity and prices of auto parts. As we’ve analyzed in our write-up on Boyd Group Services from earlier this year, the collision repair industry is being consolidated by the top 3 MSOs (multiple store operators). In 1990, there were 65k collision repair shops (most of them independent) and that number has dropped by more than half to just over 32k. Increasing parts complexity due to the many sensors, cameras, navigation systems and other technology that are in new cars have led to parts prices going up. The cost of an average collision part has gone up more than 10% over the past 15 years.
The second tailwind is that the car parc in the U.S. has continued to age since the great recession. The average age of a car in the U.S. has gone from 10 years in 2008 to over 12 years in 2021. From Copart’s data, older vehicles that are 7+ years in age are almost 2.5x more likely to be salvaged vs. a car that is 6 years or newer.
The third tailwind is from the growth in international buyers. These buyers are have become a larger part of the mix starting in 2017 and now account for more than 35% of the units sold in Copart auctions. Just 5 years ago in FY16, the percentage of vehicles sold to international buyers was just under 20%. International buyers can buy a damaged car on auction from the U.S., ship it overseas and repair it up to the standards at the destination country and still turn a profit.
Returns on incremental capital?
Over the past 10 years, Copart has spent 89% of its capital on capex and most of the remainder on acquisitions. Typically, 80%-85% of the company’s annual capex budget is for new land development and yard expansions. The remaining capex is spent across its fleet, office related PP&E, etc.
Acquisitions have been sporadic and haven’t contributed much to the company’s capital spend since FY17. Copart’s larger acquisitions over the past 10 years were in 2013 and 2017, but even these were small, tuck-in deals. The company rarely discloses acquisitions metrics because they don’t really move the needle with respect to the financials and the company is hesitant to give too many disclosures.
In 2017, Copart acquired National Powersport Auctions (NPA) which is a leading non-salvage auction company that deals with powersports vehicles like motorcycles, snowmobiles and watercraft. The company also acquired an excavation company that same year to more effectively and cost efficiently develop new salvage yards. In 2013, Copart acquired Salvage Parent for $88M, which owned 39 salvage locations in the U.S. With that deal, the company also acquired Crashed Toys, which is an auction platform for salvaged powersports vehicles.
While we usually try to breakdown a company’s return on incremental invested capital by drilling down on unit economics, this is exercise very difficult to do for Copart. There are a couple of reasons for this. First, it’s difficult to isolate the financial impact of a new yard because there are a varying number of existing yards in a region. This means that the benefit that a new yard provides varies (reducing the average transportation costs and improving congestion at existing yards). New yards also reach maturity in a wide range of timeframes (between 1 to 4 years), depending on how much capacity is shifted from existing yards and the growth rate of salvaged vehicles in the region, which is largely dependent on insurance company partners.
The second reason is that the costs to acquire land vary across the country, depending on how close the yards are to metropolitan areas. Purchase prices can range from $50k per acre to $3M per acre. And because land is not depreciable (though the development on top of the land is), the benefit to cash flows for a newly acquired yard takes a long time. This is evidenced by Copart’s significantly higher capex expense (average of 18% of revenues over past 5 years) vs. its depreciation expense (average of 4.3% of revenues). The company views that owning land rather than leasing is the right strategic move for the company long term.
Even Copart’s management has stated that new yard acquisitions don’t make sense from a cap rate vs. cost of capital perspective. Here is the company’s CFO discussing the ROI for new yard expansions on the FY19 Q3 earnings call.
“Even to put it in financial terms, I think if you took a snapshot at any moment in Copart's history and said that this next parcel of land generates an ROI in the form of its cap rate that exceeds Copart's weighted average cost of capital. The answer is almost certainly no. But to give the benefit of a time machine, if you go back to the early 1990s and just talk to Copart whether we should buy land or not, now that we have the benefit obviously of hindsight, having acquired massive parcels of real estate in the United States, in the United Kingdom and elsewhere around the globe, is one of the key economic enablers of our business that's proven to be incredibly strategically valuable. We believe that will be true going forward as well.” – Jeffrey Liaw, Chief Financial Officer
Here are some other stats about the company’s salvage yards and inventory of vehicles:
Yards can store between 100-125 vehicles per acre, if the space is used efficiently.
At the end of FY16, Copart had 400k+ vehicles of inventory in its yards. With the growth rates given on the earnings calls, this implies that the company had 440k in FY17 , 457k in FY18 , 541k in FY19 , 482k in FY20 and 587k in FY21.
Copart used to target near 100% capacity for its yards during peak season, but realized that it ended up costing more money to have to borrow yard capacity during catastrophic events. So now the company targets 85% capacity at peak and 70% at peak in areas where there is high risk of these events.
We estimate that Copart has generated returns on incremental capital between 35%-60% over the past 5 years. Even as the company has increased its capital spending over the past 5 years, the returns have not suffered due to the industry’s increasing salvage rate, Copart’s success in winning more insurance partners and the company’s growth in international markets.
Copart’s growth plan is predominantly reinvesting back into the core business both domestically and internationally. In 2015, the company started to increase reinvestment to accommodate the two tailwinds of higher salvage rates and more international buyers on the platform. Copart announced the 20/20/20 plan in the middle of FY15. Under this plan, the company aimed to open 20 new yards and expand 20 existing yards in the span of 20 months.
Over the following 12 months, Copart would open 10 new yards and expand 16 existing yards. The company had only opened 3 new yards for the 4.5 years prior to 2016. The incremental capex was slated for $100M in the first year. Shortly after, Copart announced that the company was on track to grow ahead of the plan.
In terms of expanding the company’s TAM, the Eurozone and China are natural expansion opportunities. Copart is currently focused on expanding in Europe, particularly in Germany. If you combine the car parcs of the U.K., where the company already has a meaningful presence, and the rest of the Eurozone, the sizes of the car parcs are similar to that of the U.S. at 280M+ registered vehicles. China is also a region where Copart can potentially grow in the future given the size of the car parc, but the current expansion efforts there are nascent.
For international expansions, the company typically acquires a small salvage operation in targeted expansion areas. Here is the list of international acquisitions and expansions since 2003:
Acquisition in Canada in 2003
2007, 2008 acquisitions in the U.K.
Acquisitions in the UAE, Brazil, Germany and Spain in 2013
Expansions in Bahrain and Oman in 2015
Expansions in Ireland and India in 2016
Acquisition in Finland in 2018
In Europe, there is a difference in how insurance companies handle the claims process after an accident vs. the U.S. After an accident resulting in a total loss, instead of writing the policy holder a check for the PAV of the vehicle, the insurance company will typically write a check for the difference between the salvage value and PAV and it’s up to the policy holder to get the remaining value for the totaled car. To determine what the salvage value of the car is, the insurance company will get a few bids from various platforms and the policy holder has 21 days to accept the bid or do something else with the totaled car.
When Copart is in the initial expansion phase in these European countries, the company will create a track record for its online auctions by purchasing salvaged cars directly and listing them on their online auction platform. Copart has a head start in Europe because the company can leverage its international buyer base from the U.S. auction platform.
Directly acquiring salvaged cars is capital intensive so the end game is convincing insurance carriers to participate in the online auctions on consignment. Copart shows the company’s track record to the insurance carriers and the higher ROI that the carriers could achieve with the company’s online auctions. This also shows the insurance companies that they are paying too much to the policy holders in settlement and indirectly that the insurance companies are likely charging policy holders too much in premiums. The company’s CFO gives a nice detailed explanation of the company’s European expansion strategy on the company’s FY19 Q1 Earnings Call.
It does take time and showing the insurance companies many successful transactions on Copart’s online auction platform to convince them to switch to the consignment model, but it has worked successfully in the U.K. Copart started in the region with a couple of acquisitions in 2007 and 2008. The company initially bought cars out of salvage for their own account and sold them on Copart’s online auction platform. After years of showing the superior outcomes of the consignment model, many insurance companies have switched. As of FY16 Q3, 75% of the cars sold in the U.K. are on consignment.
The company is following a similar playbook in Germany with the acquisition of Wreck Online Marketplace in 2012. Copart opened an auction location near Hannover in 2016 and then 6 more yards in 2018. The company is expecting to increase the number of locations past 12. Auction volumes have increased by 10x from the 1 year period between FY18 Q3 and FY19 Q3 (the latest data the company has given).
With a reinvestment rate between 35%-45% and a return on incremental capital between 35%-60%, we estimate that Copart has increased its intrinsic value between 16%-21% over the past 5 years. The reinvestment rate moved up starting in FY17. The company has been able to do this with a very conservative balance sheet (it’s still family run) with a net debt/EBITDA position below 1x.
What else is important?
Coming out of the Covid recession
Copart’s management considers the company to be somewhat recession resistant. Typically in a recession, used car prices move lower as lower income consumers become less likely to purchase a car. The counteracting force to this is that salvage rates go up, assuming that repair costs remain the same. That’s because the PAVs go lower, which would mean more insured cars are considered total losses. Even with the number of miles driven coming down in a typical recession, accident severity tends to move a bit higher as people drive at higher speeds with fewer congested roads, which increases the salvage rate per accident.
Coming out of a recession there is usually a recovery in used car prices. And while not every recession is the same, when consumers get their jobs back and feel financially more secure, they go out spending again, which leads to more competition for the same assets. This is what’s happened after the Covid related recession of 2020. And given that there was so much fiscal stimulus and a supply shortage in many key components for new automobiles, used vehicle prices have increased more in 2020 and 2021 than in many years prior.
This has resulted in much better than expected revenue growth for Copart because even on consignment ~half the fees are related to the final purchase price of the vehicle. Gross margins have also jumped higher. Typically following a spike in used car prices, the negative offset would be volumes because the PAVs move much higher and fewer cars are being considered total losses, but volumes haven’t come down as much to offset the ASP increases.
Copart has seen increases ASPs at a higher rate than the Manheim Used Vehicle Value Index since the company started disclosing y/y ASP growth in 2017. That’s partly due to the fact that the company has been successfully improving the liquidity of its auctions by attracting more international buyers. Over the past two quarters, the ASP growth on Copart’s platform has come down below that of the Vehicle Value Index, but that’s due to the high compares from the prior year. On a geometric two-year stack the company’s ASP growth has been higher than the Vehicle Value Index for every quarter since FY18.
This is one of the key items to consider when valuing Copart’s future growth potential. How much higher can ASPs grow and if/when ASP growth turn negative, what will that mean for volumes? Another factor to consider when valuing Copart’s future growth is the ceiling for the industry’s salvage rate. Is it possible to reach 25% or 30% (or even higher) and in what time frame?
Relationships with insurance companies
Insurance companies represent 80% of the company’s supply of salvaged vehicles (and IAA as well) and that’s unlikely to change anytime soon. Because this market is dominated by Copart and IAA as a duopoly, it’s important to consider the relative markets shares of these two companies going forward. There is the idea that the insurance companies want to work with at least two different salvage auction companies because they don’t want consignment fees to creep higher. However, there is mechanism in place to control fee inflation and that is the returns the insurance carriers get on their auctions. If the fees creep up, more cars would be repaired vs. declared as a total loss.
For the insurance companies, even if they go 100% with Copart or IAA as salvage partners, the ROI calculation may be enough to keep the auction platforms from increasing consignment fees too much. But because the salvage companies are quite necessary after a catastrophic event, it may be prudent for many insurance carriers with coverage in those regions to partner with both companies. The insurance companies will want to make sure that there is ample capacity in the case of a catastrophic event. Copart recognizes this and has added more excess capacity in those regions. The company’s stance on relationships with the insurance carriers from the F21Q1 earnings call is below.
“I think the exclusive deals are a reflection of a strong relationship with those customers. It's not per say that we have American Airlines Platinum status with warm nuts at the front of a plane per se. It's more just a reflection of the excellent returns it generates, the excellent service we provide to them. So there's no secret ring per se, Greg. But we work like hell to earn that trust from our customers. We earn it in the day-to-day in the pickup and towing of vehicles and the auction management returns we generate and the title work we do for them. And certainly we work like hell on catastrophic events to make sure that we are the most responsive, that we have the most people and process and technology on the ground to serve them at those critical moments. So those exclusive agreements are a badge of honor for us that we work like hell to earn.” – Jeffrey Liaw, Chief Financial Officer
Comparison to IAA
IAA was spun out of KAR Auction Services in 2019. Going back to 2017, the revenues of the two companies weren’t that far apart. Copart was just 20% larger in terms of revenues (though much larger in terms of operating profit). Since 2017, IAA has grown revenues at a +4% CAGR while Copart has grown at +15% CAGR up to FY20 (+17% up to FY21). One of the key differences has been the reinvestment rates that Copart has been able to achieve with its growth efforts in the U.S. and internationally.
It also seems like Copart runs a much leaner and efficient organization, evidenced by the higher margin profile, even after accounting for the fact that IAA mostly leases their land vs. Copart who opts to purchase land where possible. Operating leases for IAA accounted for 9.8% of revenues in FY20, but the company leases more than just land. It also leases software, automobiles, trucks and trailers. But if we assume that the land leases are most of the lease expenses at 8%-9%, the operating margin net of these expenses would still fall short of Copart’s by more than 5%-6%.
IAA’s margin expansion program after its spinout is also a giveaway, since the company was able to quickly identify $104M-$122M in potential annual cost savings (or 7.5%-8.8% margins on FY20 revenues) on things like digital transformation, pricing optimization, towing optimization and branch process improvements. Keep in mind these cost savings are on projected FY24 numbers, so the margin contribution (assuming there is revenue growth) will be smaller.
After the spin out, IAA has been more open to purchase land like Copart and is more focused on expanding internationally. The company has made strides in growing in the U.K. as Copart has seen success in converting many of the insurance carriers partners to sell on consignment. IAA was also able to finally conduct all of the company’s auctions online (vs. a hybrid of in-person and online) due to the impact of Covid in April 2020.
One of the reasons that more vehicles are going into salvage even with better safety technology in many new cars is due to the rising costs of repair and the increasing complexity of parts. That is to say vehicles have gotten much more expensive to fix with all the extra safety measures, especially over the past decade, but the accident rate hasn’t moved that much lower.
But if sometime in the future, there is a truly autonomous network of cars driving on the road and the accident rate is minimal (aside from product failure) the business of remarketing salvaged cars becomes challenging. In this scenario, it’s likely that all of the cars on the road will have to have this capability to achieve the minimal accident rate.
So there is a scenario where Copart’s business has a high level of terminal risk, but (1) this would require this autonomous vehicle technology, (2) the entire carparc would need to be replaced (and who would pay for this?), and (3) people would have to be willing to adopt this technology en masse.
Geographic expansion is where more of the reinvestment opportunity will be in the future. If the company can successfully replicate the U.S. model in the U.K. and Germany, there’s no reason that it couldn’t also be done throughout other areas of Europe. The international buyer base from Africa and parts of Asia will also like that transportation costs could be lower coming from Europe rather than the U.S.
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Thanks for a well articulated and researched piece Hamilton. One question - I didn't understand the right to win in international geos? There is network effects and location of yards advantage in US, I assume one can put in capital initially (1P model rather than 3P) and create liquidity for network effects to kick in, but if the yards are an important part of the moat puzzle then with getting in late into the geography, would Copart have cheap access to attractive yard locations? Also, have they broken down economics of international ops? Thank you.
Thanks for the brilliant analysis. One question - how will the EV trend influence the thesis? I guess the lifecycle for a vehicle would go down and residual value of an EV may go up as battery materials are quite expensive and some metal recycling companies may come to the field?