Investment Theses

Investment Thesis Copart

16-07-2020

2020-07-16

INDIVIDUAL POSITION - Copart

The volatility of the past few months has given us the opportunity to add some quality companies to the portfolio at reasonable valuations. An example is Copart. Copart operates one of two US auction platforms for passenger cars declared a total loss. Here is why this is a high-quality business with high growth prospects.

When a car is damaged, it is up to the insurance company to determine whether the car should be repaired or whether the owner will be paid the current market value. If a car has a current value of 10 thousand euros, the estimated repair costs are 7 thousand euros, but the damaged car can be sold for more than 3 thousand euros, the insurance company will declare the car a total loss. Traditionally, this car was then sold to the nearest dealer for useful car parts. However, the more potential buyers there are for a car, the higher the price will be. This is where Corpart's auction platform, where the car goes to the highest bidder, can add value.

Coparts business is difficult to replicate for two reasons. First, an auction must have sufficient liquidity, that is, buyers and sellers. Copart has more than 750,000 members, 10% of which are outside the United States (Canada, Mexico). Without a similar number of members it is impossible to offer insurers the highest prices for their cars and without insurers with a wide range of cars you will not get sufficient members. In other words, there is a strong network effect. Second, Copart has a dense network of junk yards where cars are temporarily stored before they are picked up by the buyer. Such a network must provide national coverage so that insurers across the U.S. can go to the same auction partner. It must also have spare capacity if, for example, a hurricane temporarily increases the number of damaged cars. But the availability of suitable locations is quite limited: a junk yard should be near a major city, yet far enough away that no one needs to live next to it.

This has led to a market with only two providers with sufficient liquidity and a dense enough network: Copart and Insurance Auto Auctions (IAA) together hold a 80% market share. Insurers divide their business between these two companies in order not to give either too much bargaining power.

Copart's business is more or less insensitive to the business cycle. The amount of profit that is made is a function of the amount of kilometres driven, the number of accidents per kilometre and the average selling price per car. In a normal recession, slightly fewer kilometres are driven because fewer people drive to work. For example, after 2008 the number of kilometres driven decreased by 3.2%. In contrast, during the recession after the dot-com crisis, the number of kilometres driven increased; the events of 9/11 caused fear of flying in much of the US population.

Obviously, a pandemic that forces everyone to work from home will have a negative impact on the business and Copart faces some difficult quarters ahead. At the low point in March / April of this year, 60% less kilometres were driven in the United States. However, drivers took more risks on the empty roads and thus percentage wise caused more accidents. Data from TomTom and Apple Maps show that car traffic is now back to pre-Covid 19 levels. Our expectation is that because of Covid-19, just like after 9/11, people will make less use of public transport or airplanes and will make more use of cars.

In addition to the defensive characteristics of the business, there are also significant growth opportunities. In the last ten years, profitability grew by 16% per year. Since the IPO in 1994, profitability even grew by 52% per year.

First of all, from the increasing complexity of cars. Cars today contain more expensive elements such as sensors, computer systems, cameras and airbags. Also, more expensive materials such as carbon and aluminium are often used. This makes repairs more expensive and total-loss statements more attractive. In the 1980s, 4% of all damaged cars were declared a total loss. Nowadays this number is 18%. Since the average car in the US is 12 years old and does not yet contain these sensors and high end materials, this trend will continue when these cars are replaced by more modern ones.

Second, of the 13 million cars declared total-loss per year, only 5 million are currently sold through Copart or IAA. The other 8 million cars are likely to yield insurance companies more if they are also sold through an auction. The trend towards auctions can therefore continue for some time to come.

Third, Copart is expanding the company to Germany and the United Kingdom. The European market is similar to the US 20 years ago, with direct contracts between insurers and dealers. Due to its debt-free balance sheet, Copart may be able to take advantage of financial difficulties that smaller competitors face, in order to create a network in Europe as well.

Finally, Copart is gaining market share from IAA. Copart made the strategic choice to do the auction 100% online as early as 1998. IAA still has a shared online / offline process, which is less than ideal in Covid-19 times.

In conclusion, we think that Copart is a very defensive business and, despite the high growth in the past 30 years, still has a long period of high growth ahead.

Copart founder Willis Johnson the non-executive chairman of the company. He is still actively involved in business operations and owns over 8% of the shares. His son-in-law, Jay Adair has been CEO since 2010 but has been with the company since 1989. In his book ‘Junk to Gold’ Willis Johnson delves deeper into Copart's history and the battle with IAA. A highly recommended read!

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