Copart Inc

An unregulated utility?

We take an opportunity to write about Copart, Inc. (CPRT) which is one of our favoured and long-held investments.

What happens to cars, which are written off in accidents/ or natural disasters or severely damaged, after the insurance settlement?

Copart takes these vehicles and auctions them. It provides the vehicle suppliers, primarily insurance companies, with a variety of services to process and sell salvage vehicles through auctions. Salvage refers to old cars which are so badly gone they need to be "salvaged” for parts. 

The buyers are mostly rebuilders, licensed dismantlers, recycled parts resellers, individual hobbyists and used-car dealers and exporters. 

The company has replaced live auctions with Internet auctions using a platform known as Virtual Bidding Third Generation (VB3 for short).

It also provides services such as towing and storage.

Source : Quartr

Source: Copart Presentation

When a car gets into an accident, an insurer must determine whether the vehicle is worth saving. It does so by comparing the cost of repairing the car versus the amount it could realise by selling at a salvage auction.

We can illustrate with a numerical example. Suppose, a car is valued at US$10,000 before the accident (this is the PAV- Pre-accident value). An accident occurs and it will take US$ 6,000 in repairs to restore the car to its PAV and another US$ 1,000 to supply the claimant with a rental while the car gets fixed.

The economic decision for the insurer is as follows:

If the likely value of the car at the salvage auction is at least US$ 3,000 ( US$10k minus US$ 6k minus US$ 1k), the insurer will choose to send the car to salvage.

If, on the other hand, the likely value of the car at the salvage auction below US$ 3,000 - the insurance company will repair the car otherwise.

Let us consider the first scenario. If the car nets US$ 4,000 at auction, the cost for the insurance company will be US$ 6,000 (they will settle the claim for US 10k but will receive the proceeds of the auction).

In the second case, they will pay US$ 6,000 for the repair and US$ 1000 for the rental care. The total cost in this case US$ 7,000.

Copart Inc comes in when the insurance company decides to write-off the car, settle the claim, and auction the wrecked car. It offers vehicle sellers a full range of services, which expedite each stage of the sales process, helping to maximize proceeds and minimize costs.

These are the services offered by Copart Inc.

online seller access to auction platform.

• salvage estimation.

• End-of-life vehicle processing (storage costs, listing, processing fees).

• Transportation services (towing)- towing is mostly contracted out but Copart maintains 350 towing vehicles.

• Storage costs (charged to buyers who do not immediately collect cars)

Copart Inc offers a full  recycling services for salvage cars.  

Copart provides its services in North America, UK, Germany, UAE, Oman, Bahrain, Brazil, Ireland, Spain and India. The US accounts for more than 80% of sales. Copart Inc. has facilities in every US state except North Dakota and Vermont.

80% of sales are sourced from insurance companies. Copart also sell on behalf of banks, dealers, or others. No selling client represents more than 10% of revenues.

Sellers generally sell on a consignment basis either for a fixed fee or a percentage of the sale price. Occasionally, companies purchase vehicles from the insurance companies, and resell the vehicles for their own account. Vehicles are usually purchased at a price based on the vehicles’ estimated pre-accident value (“PAV”) and the extent of damage. However, in the US Copart is overwhelmingly a selling agent and not a principal.

The amount that Copart makes varies between 20% -45% of the selling price of the wrecked car. Very low value cars incur a higher take rate.

History of Copart

Copart was co-founded in 1982 by Willis Johnson, who had owned and operated a singe-location auto dismantling business for more than 10 years prior to this. He expanded the company into a network of four California salvage yards by 1991. In the next two years, Copart nearly tripled the number of salvage operations it owned by acquiring companies throughout the USA. HPB Associates, a private investor group, came on board in 1993, buying 26% of the firm for $10 million, and the company went public the following year (1994).

Copart doubled its total facilities in 1995 with the acquisition of NER Auction Systems, the largest privately held salvage auction company in the US. The firm acquired or opened more than 30 facilities between 1995 and 1997.

In 1996, Copart created their company’s website and started uploading pictures of each vehicle. In 1998 a primitive online auction system was introduced but physical auctions continued. In 2003, the company went 100% online on their bidding platform. This meant buyers from all over the US, and beyond could bid on Copart’s platform. This increased the sale price of the vehicles by increasing the number of people that can bid on available inventory without being at the yard itself.

Between 1998-2005, the company expanded via acquisitions into various new states across the United States through acquisitions or opening new locations. The company consistently acquired land parcels either as a result of acquisitions or by purchases. Huge land lots are needed for the collection and storage of the cars prior to auction. The largest Copart scrapyard is in Long Island, New York. It has 97 acres of land and houses over 10,000 vehicles.

There is a strong case for ownership of land rather than renting and leasing it despite the high initial capital outlay. Leasing means there is a risk that landlords can break the contract suddenly causing great disruption to the business.

If yards are far from an accident, towing fees would start to eat into the bottom line. Therefore, there is a need for a high density of yards in order to keep towing costs low.

Originally when Copart had physical auctions, buyers had to be there in-person and scrapyards had to be close to population centres. This is less of a consideration now given the shift to internet auctions.

The key customers are Insurance companies. They prefer to sign with national contracts with national companies which have an extensive national network of well-established Yards and a long experience of providing salvage services. They also like to sign with companies which can deal with natural disasters such as hurricanes where large numbers of damaged /written-off cars need to be dealt with in a short period of time.

In June 2007, Copart acquired Universal Salvage, the operator of about 10 salvage yards in the UK and a vehicle remarketer to the insurance and automotive industries. The company also broadened its existing range to farming equipment in the UK when it acquired Hewitt International, an auctioneer of agricultural vehicles and equipment based in central England, in 2011.

During 2008, the company launched CopartDirect. (branded as cashcars.com ) to sell undamaged cars to the general public, using its VB3 application

In 2012, the company made several acquisitions in international markets, including Brazil, Canada, Germany, and Dubai, UAE.

Fast forward to today, the single location business of 1982 now controls 53% of the US market while Insurance Auto Auctions (IAA) has a market share of 35%. The top two companies combined control over 88% of the market. The balance is shared by a number of smaller players. Copart has over 175,000 vehicles listed for sale at any given time. It has 243 locations in the United States and sells over 2 million cars every year.

They represent a textbook duopoly structure as the next largest operator only has about 3%. Both companies have built up scale advantages over 35 years that would be very difficult to replicate. We will discuss these later in this report.

IAA is now owned by RB Global (RBA). It has not performed as well as Copart. For example, IAA did not move to online-only auctions until 2020, two decades later than Copart. It is much smaller with annual net income of US$ 1.7bn and a market capitalisation of US$ 11.6bn compared with US$3.6bn and US$44.7bn, respectively, for Copart. RBA is unlikely to have the resources to fight strongly against Copart.

We will make two point about this market structure.

First, a stable duopoly can be a good area to look for promising investments. The classic ones of course, are Visa and Mastercard in Credit Card Processing or Moody’s/ Standard and Poor in Debt Rating Agencies.

Second, there is little room for Copart to achieve inorganic growth in the USA as Independents only account for 12% of the market .

Willis Johnson remains the Chairman and owns ~6% of the company (a stake worth nearly US$ 2bn). The current CEO Jay Adair is Johnson’s son-in-law and started working in the company at the age of 19. Adair owns 3.5% of the company.

The Supply of Salvage Cars

There are an estimated 298 million cars on the roads in the United States. This includes Cars, SUVs, Vans, and other medium- and heavy-duty vehicles that are registered with the relevant authorities.

Every year, around 13mn (5%) vehicles are removed from the fleet and 4mn of these end up in salvage auctions. Insurers supply 80%-85% of these with the balance accounted for by banks (due to repossessions etc), dealers and others.

Auto insurance in the US is a consolidated industry with the top 10 firms accounting for 75% of written premiums. The top three account for 45% ( see table below). No single supplier accounts for more than 10% of Copart’s revenue. 

Source: NAIC Report dated April 4th 2022.

An insurer tries to minimize its claim costs by minimizing repair costs on the cars it saves or by maximizing the salvage proceeds for those it deems a total loss. In the latter case, the highest proceeds are achieved by creating competition among a large base of potential buyers, who in turn seek a reliable source of supply across a broad range of models…buyers attract sellers and sellers beget buyers in the feedback loop characteristic of market places. Insurers also have an incentive to cut auction transactions costs but there is perhaps limited scope to do so given the duopoly power of Copart and RBA.

Who are the buyers of salvage cars at auctions?

Dealers, repair shops, individual hobbyists, overseas buyers and parts recyclers are among the buyers of salvage cars. They do so with a view to rebuild or dismantle for parts.  

Vehicle dismantlers are the largest group of buyers. They dismantle a salvage vehicle and sell parts individually or sell the entire vehicle to rebuilders, used vehicle dealers, or the general public.

In general, buyers of the salvage cars are smaller and more fragmented than the sellers. There is one exception to this which we will note here.   

LKQ Corporation (LKQ),  a listed company with annual revenues of US$ 13bn is a major buyer of salvage cars.  They sell parts, including re-cycled parts, to collision repair shops.  The latter buy from LKQ to appease cost conscious insurers who direct huge repair volume to the shops. The insurers give a preference to shops using less expensive recycled parts for damaged cars. Insurers account for 85 percent of repairs and therefore are an influential force in the “repair”  market

Insurance companies pressure repair shops to use recycled parts that sell for half the price but are nonetheless just as reliable as OEM replacement products, a significant demand tailwind for distributors of recycled salvage parts. For every five cars that are involved in accidents, one is sent to a salvage auction, where it might be claimed by recycler like LKQ who sells the parts used to repair the other four. 

In 2003, Copart embarked on a journey to conduct all its auctions in online. These virtual auctions are split into two phases. The following description of the Auction was written by the The Rational Walk.

Phase 1 

In phase 1, which starts 3 days before the live auction, buyers submit the maximum price they are willing to pay for a vehicle and Copart’s system incrementally bids up to that price on behalf of the buyer, who receives an email if he is topped. So everybody gets an idea of what the highest price for the car somebody will be willing to pay. He may not pay that - but it does create some expectations of what the likely high  price is going to be. A lot of  price discovery has happened before the auction takes place.   Phase 1 is an open bid format similar to eBay.

Phase 2

The winning bid in phase 1 sets the starting price in phase 2, when bidders compete in a real- time virtual auction environment.

Phase 2 allows bidders the opportunity to bid against each other and the high preliminary bidder. The bidders enter bids via the internet in real time while BID4U submits bids for the high preliminary bidder up to their maximum bid. When bidding stops, a countdown is initiated. If no bids are received during the countdown, the vehicle sells to the highest bidder.

More than 60% of auctioned vehicle are sold to buyers outside the state of the auction. In 2022, 67% of the demand was accounted for by out-of-state buyers and 36% of this was from international buyers. The latter includes buyers from Latin America, Eastern Europe and others where US cars are highly sought and safety/environmental regulations are often less strict.

Source: Copart

Photograph shows Copart Internet Auction Home Page

Copart Strategy

Copart's growth strategy is to increase revenues and profitability by, among other things:

• acquiring and developing additional vehicle storage facilities in key markets, including foreign markets;

• pursuing global, national and regional vehicle seller agreements; increasing its service offerings; and

• expanding the application of VB3 into new (non-auto)markets.

Mergers and Acquisitions

Copart has grown for years by acquiring and integrating a large number of companies in the salvage business. It has developed some expertise in integrating new businesses using its proprietary operating software and systems.

In 2015, Copart made an acquisition outside salvage when it bought National Powersport Auctions (NPA). NPA is a leading online marketplace for powersports vehicles, such as motorcycles, ATVs, and snowmobiles.

Source : NPA

Photograph above shows an NPA Motorcycle Storage unit

NPA has continued to operate as a separate brand under the Copart umbrella. It has also expanded its operations to include new locations in the United States and Canada.

It provides Copart with a strong platform to reach a wider audience of powersports buyers and sellers. The acquisition has also helped Copart to grow its market share in the powersports market.

Other Markets

The other potential market opening for Copart is selling cars that are in good condition, and not just salvage titles. The company has expanded into this space- it involves selling cars on behalf of banks and other lenders as well as individuals. This segment has seen some promising growth but it is still early days.

Overseas Expansion

As noted above, there is little room for inorganic expansion in the US and there is great interest in the company’s moves outside the USA.

The company spent a decade building its brand inside Germany with the intention of spreading to the rest of Europe, and now operates in 12 countries (the USA, Canada, the UK, Brazil, Ireland, India, Germany, Finland, the UAE, Oman, Bahrain, and Spain).

International expansion requires Copart to adjust for local insurance company regulations and business practices. In order to build trust in the auction system, some cars have been/will be purchased by the company itself (exposing it to price risk) with the expectation that insurance companies will transition to using the auctions over time.

In the most recent quarter, about 11% of Copart’s service revenues were from international markets and nearly 40% of vehicle sales revenues (where Copart buys to resell) were international. Revenues in the international segment are growing at a faster rate than the overall base but from a low base.

Copart’s historical performance

Let us look at Copart’s historical performance before considering its business model and the prospects for the company.

Chart1: CPRT Growth in Market Capitalisation

Source: Stratosphere.Io

Since 1994, the stock has given a CAGR return of 21.1%.

Chart2: CPRT Total Revenue

Source: Stratosphere.Io

In the last twenty years, revenues have grown tenfold from US$ 350mn to US$ 3.5bn.

Chart 3: CPRT 3 year CAGR Revenue Growth and 3 year Diluted EPS growth

Diluted EPS growth has usually been faster than revenue growth (see below). This indicates a degree of operating leverage in the business.

Chart 4: CPRT 10 years of gross, Operating and Net Margins

Source: Stratosphere.Io

Note: Purple line = Net Income Margin (%) and Blue line = Gross Margin (%) in the chart above.

Margins have been very stable over the last decade and Net Income Margins have gently risen. There has however been a decline in all margins in the last three years.

Chart 5: CPRT Return on Equity (ROE) and Return on Invested Capital (ROIC)

Source: Stratosphere.Io

Note: Green line=ROIC.

ROE and ROIC have declined in recent years especially in the last three years but remain at a relatively high 26% and 23% respectively.

Chart 6: CPRT Cash from Operations and Free Cash Flow

Source: Stratosphere.Io

Both Cash from Operations and Free Cash Flow have grown steadily in the last decade. The large absolute difference between them is the high annual level of fixed investment.

Chart 7: CPRT Total diluted number of shares outstanding (millions)

Source: Stratosphere.Io

There was a sharp decline in the number of shares in the ten years to December 2015. Weighted average shares outstanding fell from ~744mn to ~ 520mn. In recent years, the company has not been buying back stock but has been buying back or redeeming debt (see the chart below).

Chart 8: CPRT Total long-term debt (US$ millions).

Source: Stratosphere.Io

Long-term debt has fallen to almost zero in the last two years

Chart 9: Total Cash and Cash Equivalents.

Source: Stratosphere.Io

Not only has long term debt fallen to zero, cash and cash equivalents have grown strongly in recent years to US$ 1.3bn in 2022. As of mid-2023, net current assets are US$ 2.3bn.

Chart 10: CPRT: Stock-based Compensation as a percentage of Revenue.

Summary of historical performance

• Copart has grown very strongly and has given stellar stock returns over the last thirty years.

• The company has grown revenues and profits consistently and has been a steady generator of cash flow.

• It was a large buyer of its own shares but has refrained from doing so in recent years, presumably because share prices have been deemed too high, and instead used excess cash to buy back and/or redeem all long-term debt.

• In addition to being debt-free, the company now has US$1.3bn in cash and US$ 2.3bn in net current assets.

Strengths of the Copart business model.

The Copart business model has a number of key strengths:

• Management and Culture

• Network effects.

• Strong Moat

• Strong Balance Sheet

Management and Culture

Willis Johnson founded Copart in 1982 out of a single scrap yard in Vallejo, California. Prior to this, he had been in the scrap business for years. He had dismantled cars, sold and resold salvage parts, processed sales of metal scrap, and a had variety of other endeavours. Johnson was drafted into the Vietnam War and was awarded a Purple Heart for his service. He wrote his life story in a book called “Junk to Gold” which is an account of his life and his career at Copart.

For forty years, Copart under Johnson purchased scrap yards and implementing his approach at the acquired businesses. His yards had inventory trackers (which was unusual in the 1980s), organized clean lots, and insurance company customers.

In Copart, Johnson built a dedicated management team that lives for the business. Johnson’s obsession with efficiency and careful planning created a company that grew its brand value before its revenue, using a slow methodical approach.

Willis Johnson had the discipline to create a business from scratch, make hard decisions about what their business model was, and put an excellent management team in place. His business practices and approach is embedded in the culture of the company.

Willis Johnson became Chairman and was replaced by Jayson Adair, who is his son-in-law and started working at the company at the age of 19. He worked at Copart for 21 years before becoming CEO.

Both executives have a conservative approach to growth and capital allocation. In the early days, debt was not utilized to grow the business’ scrapyard portfolio. Johnson preferred to issue stock and raise capital via share issuances. It allowed the company to reach scale in a business and demonstrate that they had a durable business model.

Their capital allocation model has some rational elements. For a few years, they were aggressive buyers of stock. Later as the stock price rose further and perhaps became too expensive, they used their free cash flow to aggressively reduce their debt. This echoes the behaviour of the legendary CEO, Henry Singleton of Teledyne, as recorded by William Thorndike in his book “The Outsiders”.

Copart’s capital allocation strategy is pretty simple. They invest excess cash in physical assets. In particular they

• acquire additional yards to storage more vehicles, domestically and abroad

• expand current locations to handle greater capacity

• pursue more global, national, and regional selling agreements with Insurance companies.

• Increase offerings to outside of automotive: Boats, Motorcycles, etc. (“NPA”).

• Start to sell vehicles other than salvage vehicles (“Blucar”).

• Occasionally buyback a large number of shares or debt at good prices.

This explains why the company has consistent growth, stable margins, and relatively heavy capital expenditures.

Remuneration and Alignment of Interests

Both Mr. Johnson and Mr. Aldair have accumulated substantial stakes in the company. Together, they own ~10% of Copart and also have unvested stock.

The CEOs salary is just US$ 1, no cash bonus and a generous amount of stock options with different vesting periods (mostly in 5 yr cycles). They also disclose that other perks are included as compensation like the use of the corporate jet for personal use for up to 100 hours a year. This compensation scheme perhaps generates a high degree of alignment between shareholders and the CEO and forces a long-term sustainable view of the business. If the stock performs poorly, the CEO, simply won't see any benefit.

Compensation for senior management and shareholder alignment is a complicated subject and needs to be looked at carefully. As in many things, the gold Standard is set by Warren Buffett who has received a salary of just US$ 100,000 for many decades. He has never been given a stock option and acquired his ~35% stake in Berkshire Hathaway in 1965 in the secondary market. I.e. it was not a special price but one available to everybody else at the time. Buffet has a very rare fiduciary gene and it would be difficult to find somebody with a similarly deep sense of alignment and partnership with minority shareholders. The Copart remuneration scheme is interesting but we would need to examine the terms of the options and other compensation before we could opine on the fairness or otherwise of the remuneration arrangements. We hope to return to this in the future.

Network Effects

This auction house has a very powerful network effect which has helped Copart and IAA grow stronger. Sellers like to participate in auctions because the buyers are there. On the other hand, buyers go to the market because the sellers are there. In most markets such as stock exchanges the same logic applies. Most countries only have one or two stock exchanges. Attempts to introduce a third stock exchange almost always fail. Liquidity begets liquidity.

This self-reinforcing dynamic develops over years but it is cumulative as existing players capture an increasing share of the market over time. It would very difficult for a newcomer to break into the Salvage market due to the Economic Moat the existing players have created.

Economic Moat

Salvage yards are large, unsightly, dirty, industrial units that nobody wants in their neighbourhood. It can take a long time (and a lot of money) to build a new yard. In smaller cities that can’t support more than one yard, or larger cities that don’t want another one, it can lead to a local monopoly.

Source : Copart

Photograph of Copart facility in South Dallas.

Over the last four decades, Copart has developed or acquired many such yards and this would be very difficult for a new entrant to replicate. Even if they had the cash to buy the land, getting local permissions to operate salvage yards would be very difficult.

Developing relationships with the 10-15 large insurance companies who dominate the auto insurance takes time. They provide vehicles to sell and are used to dealing with the teams and processes at Copart and IAA. It would be difficult for a new entrant to win the confidence of insurance companies and win business form them.

Copart’s global reach enhances this advantage by allowing buyers from anywhere in the world to shop at a salvage yard that would otherwise only have local buyers.

All these factors imply important network effects which can act as strong barriers to new entrants to the industry and collectively represent an important economic moat.

They provide an essential service rather like a utility. However they are not regulated and have created an economic moat that is very effective in keeping out new entrants. “We’re a utility. Nothing can get rid of us – nothing. Two of the biggest businesses in the world are car manufacturers and insurance companies,” I went on. ” If insurance companies don’t write insurance policies on cars, then they’re out of business. If manufacturers don’t make cars, then they’re out of business. They’re always gonna make cars and they’re always gonna insure them. We’re the guys in between.

As long as we’ve got the land in the right place to put the cars on, we can’t fail. We are like the septic tanks of the sewer system. You can’t have the system without us.” – Junk to Gold, pg. 94-95

Willis Johnson described the company as “a sewer system”. Insurance companies need to write policies for cars and looking to minimise losses after each accident. Auto manufacturers need insurance companies to insure their vehicles. There just needs to be someone to get rid of the waste. That someone needs relationships with insurers, the expertise of dealing with Salvage vehicles and the market place. Copart has all of these and would be very hard for a new entrant to replicate however much capital they have.

This strong market franchise reminds me of comment made by Warren Buffett about Coca Cola. “If you gave me US$ 100 billion and take away the soft drinks leadership of Coca Cola in the world, I‘d give it back to you and say it cannot be done.”

Strong Balance Sheet.

A strong balance sheet is always a good source of comfort for investors. As we noted above, Copart has no long-term debt and has built up a large cash pile in recent years.

An analysis of the determinants of the business prospects for Copart’s business in the long run.

A key driver for Copart’s business in the US is the number of cars, out of 298mn on the road), that will be “salvaged” every year.

I believe there are a number of key factors to consider: 

1.    The number of cars on the road

2.    Total number of miles driven

3.    The number of accidents per millions of miles driven

4.    The percentage of cars involved in an accident which will be total loss (this is known as the Total Loss Frequency) 

Let us consider these factors in turn:

The number of cars on the road

There are currently 298mn vehicles on the road in the USA. The figure was about 190mn in the early 1990s. The growth in the last thirty years has been due to a few factors such as increasing incomes, the move to the suburbs and the rise of the multi-car households.   

The rate of growth in the number of cars has been slowing due to factors such as the growth in urban carless households, particularly among young people, and the rise in ride hailing apps such as Uber etc.  We would not expect significant growth in the number of cars on the roads going forward.

Total number of miles driven

The number of miles driven has been rising steadily for years before the Covid-19 pandemic. There was a noticeable fall during the pandemic due to the rise in work from home (WFH) but it has recovered since then. We would expect to see a modest increase in the numbers of miles driven.

Chart 11: Vehicle Miles traveled in the US.

Source: Wagner Road Capital Management

The number of accidents per millions of miles driven

There was decline in the number of crashes per million of miles driven for about 15 year as cars got safer but this rate has ticked up in recent years. This has been attributed to texting/emailing while behind the wheel. It is a serious problem. Over 30% of respondents from an AAA Foundation for Traffic Safety survey reported texting while driving in the previous 30 days; the National Safety Council claims that 1 in 4 crashes is influenced by cell phone use. 

Total Loss Frequency

Total Loss Frequency is the percentage of cars involved in an accident which will be total loss. It is heavily influenced by the cost of repairing cars and the value of used cars.   

Chart 12: Total Loss Frequency

Source: Wagner Road Capital Management

Total loss frequency has dramatically increased over the past decade, from about 15% to about 21% though our data stops at 2020. According to Lexis Nexis, total loss ratios worsened during the first nine months of 2022 rose to 27%. This suggest that  more than 1 in 4 cars, involved in an accidents, are written off. As the chart above shows, the percentage of cars involved in accidents being written off has increased dramatically in the last ten years.

There are two key explanations

• The average age of car is gradually increasing

• Cars are becoming more complex

Chart 13: Average age of US Light Vehicles 

Source: Wagner Road Capital Management

Older cars are more likely to be salvaged, as  repair costs make up a high proportion of pre-accident value. The median vehicle age has gone from ~10 years, 15 years ago to ~ 12 years today.

 New cars are also becoming significantly more expensive to repair. The two main reasons for this are a shift from using steel to aluminum and significantly more electronic components. Fuel efficiency standards have created the need for lighter materials. The use of aluminum for vehicles has been increasing for decades.  Every year, cars are packed with more and more safety features and technology – airbags, computer systems, cameras, sensors, navigation systems – making them more expensive to repair and more likely to be deemed a total loss when involved in an accident. Electronics now make up about 35% of a vehicle’s total cost, and are projected to reach 50% by 2030. 

Even if the total number of miles driven and the accident rates stay stable (the impact of safer cars is offset by more dangerous driving), the total loss frequency could rise as vehicles get older on average  and new vehicles continue to become more expensive to repair.

When considering whether a car will be repaired, another key will be the price of value of second-hand cars. This is what the insurance company will have to pay if they accept the insurance claim and send the car to salvage. Used vehicle prices are captured by the Manheim Used Vehicle Value Index which is shown below:

Chart 14: Manheim Used Vehicle Value Index

Source: Cox Automotive

The pandemic led to a shortage of new cars due to a shortage of microchips.  Demand for cars fell while the demand for computer equipment took off (WFH etc). Car manufacturers reduced output and chip manufacturers, signed more long-term contracts with computer equipment makers. When demand for cars returned, car makers were unable to secure enough microchips, because that production capacity had been sold to other sectors. There were media stories about how a US$ 80k car could not be produced due to non-availability of chips worth US$10.

Chip supply conditions should normalise and the price of used cars will fall in the long-run. As the chart above indicates, this has already started to happen.

The higher used car prices should lead to more cars being repaired (and fewer cars being totaled). This would be negative to Copart as fewer cars would be auctioned. However, Copart has an offsetting effect, as their take is a percentage of the sale price and the latter rose in line with the prices of used cars.

Impact of Autonomous Vehicles (AV)  

In the long run, autonomous vehicles (AVs) should reduce accidents as they are likely to be much safer than human-driven cars.  However, this still imperfect and evolving technology will play out over decades and will not have a major impact in our time horizon as mass adoption will take decades. 

Our best guess is that salvage volumes will continue growing at high single digit percentages and high repair costs will continue to lead to an increase in the total loss factor.  Most of the value of this growth in salvage vehicles will accrue to the the two largest players, Copart and RBA who together share 80% of the US market.

Global Opportunities

The salvage vehicle auction business is mature in the United States (two companies already have ~ 90% of the market, so future inorganic growth is limited).  However, the market is much more fragmented in the rest of the world.

Copart’s foreign expansion has been going relatively well. Since the initial expansion into Canada in 2003, the expansion to new countries has been slow and steady:

• Canada in 2003

• UK in 2007, 2008

• UAE, Brazil, Germany, Spain in 2013

• Bahrain, Oman in 2015

• Ireland, India in 2016

• Finland in 2018

Since 2019, Copart has opened/acquired 2 operational facilities in Brazil, 10 in Germany, and 26 in the United States. Longer term, Copart is looking to expand to India and China.

It is likely that international growth rates will be faster than US growth rate albeit from a low base. However, international business will be more risky due to more fragmented, smaller markets with different rules and regulations.

Source https://insurance-edge.net/2022/07/12/deals-copart-buys-hills-salvage-recycling/

Photograph shows Copart trucks in the UK where Copart has been expanding by taking over existing salvage companies.

Overall growth rates are unlikely to be as high as they were in the three decades when Copart was grabbing market share in the USA and global markets are likely to be less profitable. Therefore, the recent decline in margins and profitability are unlikely to be easily reversed. However we have no doubt that Copart will grow successfully and profitably in global markets given their decades of experience in salvage and unrivalled financial and business strength and scale.

Summary

We will present the summary as a SWOT analysis.

Strengths

• The company has a very strong balance sheet with strong financial returns.

• A company with strong network effects that allow it to operate as an unregulated duopoly.

• A management team that is heavily invested and incentivised and includes the company founder. Senior management remuneration is structured so their economic interests appear to be aligned with those of shareholders.

• Many opportunities for reinvesting in growth esp outside the USA where they have established important businesses in the last two decades.

Weaknesses

• The company may take some additional market share against IAA and other players but there is little scope to do so. Too much progress here could attract regulatory attention.

• The overseas expansion requires Copart to buy some cars on their own account and this exposes them to inventory price risk.

• The overseas expansion strategy might not take off, due to the nature of insurance policies in other countries, regulatory concerns, or due to Copart not being able to implement the online model with the same synergies as they have achieved in North America.

• The company faces catastrophe risk. It is called in during storms, hurricanes and other natural disasters and loses money on this.

Opportunities

• The company has a presence in overseas markets as diverse as UAE, UK, Brazil and India among others and growth in these and other markets from a low base is the key opportunity

• The company has the opportunity to use their auction technology in other markets such as used cars, boats and motorcycles etc .

Threats

• Regulatory or other problems could reduce or eliminate profit in foreign markets.

• The rise of safe Autonomous Vehicles (AV) might reduce the accident rate significantly and therefore the supply of salvage cars that Copart’s business model relies on might dry up. This is only a long -term threat.

An unregulated monopoly?

An unregulated monopoly is a very good place to look for a perfect equity investment. However, market forces and regulators combine to ensure that these are extremely rare. There are a very few unregulated duopolies and Copart is one of them. Their position is so strong and the barriers to entry are so well established that it is difficult to see a new entrant entering this market, at least in North America.

This is a very strong company and there is little chance of permanent loss from an investment this company over the medium term.

This note’s subtitle is “An unregulated utility?” Copart. Inc provides an essential service similar to utilities. Traditional utilities provide electricity, water, gas, waste collection and other essential services that consumers need and for which there are few or no substitutes. The demand for these services is price insensitive or price inelastic. Utilities are also highly capital intensive and need to operate at high scale to minimise average unit costs.

Therefore, the markets tend towards a market structure of a few large suppliers. The combination of oligopolistic market structures and price insensitivity gives scope high prices and excess profits. This is the reason that utilities are often regulated and their ability to raise prices restricted.

An unregulated utility could be very profitable for investors. Salvage cars have to be processed just as much as waste/refuse has to be collected and dealt with and managed. Therefore, a strong case can be made for it being an unregulated utility.

It seems to be a solid, safe long-term investment with some promising optionality arising from overseas expansion.

Valuation

Let us look at some familiar quick and dirty valuation metrics of Copart in order to get some sense of the valuation of the shares of the company. On the basis of these, the shares do not look “cheap”.

Chart 15: CPRT: 20-year Forward Price to Sales Ratio  

Source: Stratosphere.Io

Chart 16: CPRT: 20-year Forward Price to Earnings Ratio  

Source: Stratosphere.Io

Chart 17: CPRT: 20-year Forward Price to Operating Cash Flow

Source: Stratosphere.Io

Chart 18: CPRT: 20-year Forward Price to Free Cash Flow Ratio

Source: Stratosphere.Io

Chart 19: CPRT: 20-year Forward enterprise Value to Sales Ratio

Source: Stratosphere.Io

Chart 20: CPRT: 20-year Forward Free Cash Flow Yield

Chart 21: CPRT: 8-year Return on Equity data (%)

The data shown above show the Forward Price to Sales Ratio of 10.9 times, a Forward Price to Earnings Ratio of ~ 34 times and Free Cash Flow Yield of 2.5% among other metrics. These do not indicate a “cheap” stock. However, one would not expect a company with well-known fortress-like qualities to trade cheaply.

Conclusions

However, it could be argued that a company with an ROE/ ROIC of ~23% to ~26% and an operating margin of ~ 37% is only slightly overvalued at current valuations. Given the obvious strengths of this company, this premium could well be worth paying. We hold this company in our portfolio and will continue to do so. We will review it again when they release their quarterly results on September 6, 2023.

Annexe 1: Highlights from Recent Conference calls with the Management of Copart

“Our capacity expansion efforts are -- have been ongoing for years. You first heard about the 2020 initiative in the spring of 2016, so that six years ago and our land acquisition, as you know, during that period of time has been elevated even relative to our history, during which we bought lands almost as much as we could find.”

“Nowadays those land purchases continue and we do believe we are well equipped to handle a cyclical rebound as used car prices decline, so we can handle that volume as it comes, but we are still purchasing land in anticipation of future growth as well. Both in the day-to-day business, as well as our catastrophic readiness, in light of increased volatility, it's not just the need for more land overall, it's also to accommodate greater volume, it's also an increased ability to handle spikes that are attributable to storm activity as well.”

“Our cash for cars business, where we buy lower value vehicles directly from consumers that's been growing rapidly, we've made great progress there and it's incremental liquidity in the marketplace, so we're happy to have it, it doesn't displace other business in the US per se.”

“Historically, the logic there was we wanted to have some capacity (for towing) to serve, in particular in storms because that's when drivers are of course in the shortest supply. Our catastrophic fleet, so to speak, to serve our customers and their times of need and ours.”

”We are also evaluating doing more of that towing) on a day-to-day basis as well. Not per se, because of the fortress balance sheet, but because it may allow us to better serve our customers and so we have purchased certainly meaningfully more trucks in the past couple of years than we had previously for that express purpose.”

“Technology solutions that can help increase efficiencies for our logistics, including by the way, expansion of footprint in every new yard we add reduces to some extent, the miles that any given car has to be towed to get to a Copart facility. But as well as our technology, our location-based driver perhaps which help to better dispatch, better deploy our drivers, whether they are in-house employees or third parties.”

“on direct purchasing of  low  volume cars -  Historically we used to call it Copart Direct internally, but we would been branding it as Cash For Cars ( cashforcars.com)  and we've put pretty dramatic resources into that business over the last couple of years and have seen pretty significant growth.”

 Comment from Mr. Aldair in the FY22 letter to shareholders.

We have long prided ourselves on making decisions for the long-term benefit of our customers, our people, our shareholders, our communities, and the world around us. Our framework is simple, but not easy. We have committed our time and our capital in pursuit of durable excellence in ways that were at times contrary to prevailing wisdom, including for example our investment in owning our land and our conservative capitalization, among many other such cases.

“We continue to make decisions for the 30-year prosperity of our customers and our shareholders. We will invest in the technology of today and tomorrow to enable us to serve both our members and our sellers.”

”We will invest to recruit members to engage them and to expand the marketplace of services available to them to continue to expand. We will invest in land. We will own our land whenever possible to ensure that our ability to serve our customers is never compromised by the whims or economic optimizations of third-party landlords.”

“We excel at managing high volume online auctions and recruiting the sellers and buyers for them. We think we excel at physical infrastructure, both the development of greenfield facilities and the acquisition of existing ones, and then managing the physical logistics to and from those facilities of high volumes of physical equipment and high volumes of vehicles historically.”

”And, we  navigate complex regulatory environments. We have 50 different  (Dept of Motor Vehicles)   DMVs in the U.S. alone as well as a number of other relative -- regulatory layers here and certainly worldwide tax and otherwise, we think we are uniquely equipped to address. And we've taken and looked at those capabilities and asked ourselves the question of where can we deploy those into adjacent spaces to grow the business over time, and have done so selectively and very conservatively as you know. We've expanded with our acquisition of NPA five and a half years ago or thereabouts into the Powersports arena.”

“We today are expanding this BluCar initiative into the whole car space as well. And frankly, within Yellow Iron, as you just inquired, we already sell within Yellow Iron specialty equipment, trucks and trailers and the like and many hundreds of millions of dollars of that equipment every year without per se a dedicated effort to expand our business there.”

“In late September of this year, Hurricane Ian made landfall in Florida.On a unit volume basis. Ian will be the single largest storm event in Copart's 40-year history, this category 4 storm, included heavy rainfall and winds and excess of 150 mph and cut a path through the heart of the state. Ian proved to be a storm of historic proportions. The robustness of our response was the fruit of seeds we've been planting for year. We tend to experience operating losses in major weather events, Hurricane Ian in the first quarter is no exception with $25 million in extra cost incurred by our business, offset by $9 million of revenue in the period.”

"Our evergreen position is that we take our responsibility as stewards of capital seriously and evaluate prospective investments with an owner's mindset because we are owners; from Willis Johnson, our Founder, to our newest employees who elect to participate in our employee stock ownership program. We prioritize investing in our core business, land and technology, in particular."
"I do want to emphasize how the strength of our balance sheet empowers and differentiates Copart. In comparison to other participants in our industry, we do not prioritize interest payments, debt paydown, dividends or massive cost reduction initiatives. We can deploy our resources, specifically our capital and our management bandwidth, to prioritizing the long-term prosperity and satisfaction of our clients.”

“First, we can continue investing in our owned real estate portfolio, which provides strong durable protection against an inflationary environment and also ensures the sustainability of our service model for the next 50-years. Second, we can provide superior service to our clients and catastrophic events even when doing so requires substantial capital investments in technology, trucks, land and people.”