Eonia Research Moat Series
At Eonia Research our objective is to produce actionable investment insights through deep, bottom-up research. Although our primary focus is listed biotechnology and healthcare companies, we acknowledge that the average investor may be uncomfortable with the volatile nature of biotech investing. We therefore decided to produce a Moat Series, ideas we believe represent long-term buy and “hold forever” opportunities. In this article, we introduce one such company.
Copart (CPRT) is the leader in online auto salvage auction with a robust economic moat. The company has a very healthy financial position and our proprietary factor model indicates that it ranks in the top 1% of Quality stocks globally out of our 6,000 global stock universe. Investors should take advantage of current market conditions to buy an outstanding compounder at a reasonable price. We arrive at a fair value of $90 per share, representing about 20% upside from current level. We are long Copart and recommend it as a buy.
Copart’s business model is simple, it takes damaged or recovered vehicles and auctions them for insurers, dealers, fleet operators, banks and charities. The company operates the largest online auction resell marketplace for vehicles with 81% of sales from the US and 19% abroad. Buyers on Copart are predominantly re-builders, used car dealers, dismantlers and exporters. The company provides complementary services to its online-only marketplace including tow, storage and paperwork – it owns over 10,000 acres across >200 facilities in the USA and aboard, picking up over 250,000 vehicles a month. We believe Copart possesses strong competitive attributes in addition to high growth prospects, which together bode well for this superior compounder.
Figure 1 demonstrates Copart’s 5-year cumulative relative performance vs. the S&P 500 (blue) and relative performance vs. the S&P 500 Diversified Support Service Sub Industry Index (yellow). Copart’s strong relative performance profile is an indication of investor under-reaction to Copart’s strong business and is congruent with that of a stable compounder.
What Copart Has
Copart has a set of strong fundamental characteristics, which make it an attractive long investment opportunity.
Excellent quality: Before delving into the qualitative aspects we believe contribute to the quality of the business, it is worth observing how Copart ranks in our global equity quant model. We examine the stock’s cross-sectional characteristics, as per our proprietary quantitative scoring model, in order to understand if the business is attractive on a quantitative basis. The Eonia Research factor model universe consists of over 6,000 global stocks, which cover a broad representation of a liquid universe above $900m in market cap. For these stocks, we calculate and aggregate over 120 sub-factor scores (daily) into 3 factor groups:
- Value – seeks to measure the degree of pessimism reflected in a stock’s price with respect to its fundamentals. We include measures like Price/Sales, Price/Earnings, and Price/Cash Flow into our Value composite.
- Quality – seeks to capture the degree of quality of earnings. We include measures like Gross Margin and Return on Invested Capital into our assessment of Quality. Stocks with high Quality scores tend to exhibit economic moats.
- Momentum – seeks to capture the degree of under-reaction reflected in a stock’s price action over time. We incorporate 12-month stock return and EPS revisions into our Momentum factor.
Our factor model (Table 1; higher score is better) indicates that Copart possesses exceptional Quality, it ranks in the top 1% of stocks globally. Furthermore, the company’s Momentum has been strong, it sits comfortably in the top 15% Momentum segment. Given the stock’s high Quality and Momentum characteristics, it is only logical that investors pay more for such an asset – it therefore ranks in the most expensive third of the market on a Value basis.
Duopoly: There are 2 dominant players in the US salvage auto auction industry, one is Copart and the other is Insurance Auto Auctions (IAA) (IAA was spun-out from KAR Auction Services (KAR)). Each player controls roughly 40% of the market; Copart is more dominant in the online-only channel due to its online-only auction model. IAA’s hybrid model is more high-touch due to the in-person auctions they run; 70% of IAA’s North American vehicles sold were online in FY 2019.
Disclosed market share statistics put IAA and Copart on an equal-footing in terms of US auto salvage market share. Each company has 40% of the market in North America; the remainder being occupied by smaller, niche operators including mom-and-pop operations. Examining higher frequency data on web-traffic and mobile app usage puts Copart ahead of IAA by a decent margin based on:
- Copart’s global Alexa rank is 3,166 vs. IAA’s 5,608, roughly 40% lower.
- SimilarWeb’s traffic ranking similarly places Copart well ahead of IAA as shown by focusing on the US Automotive Industry category in Table 2.
Table 2: Web ranks for the US Automotive Industry category (Source: SimilarWeb)
- According to major Appstore data presented in Table 3, Copart’s mobile app engagement compare much more favorably vs. IAA’s with about 3x the number of downloads in March.
Attractive market dynamics: Insurers have ceased trying to sell direct to the end customer – owning or leasing salvage yards and running auction websites and facilities is not their core business. This means incumbents are unlikely to be threatened by disintermediation by the main sellers (insurers) on their auction platforms. Furthermore, buyers accessing auction platforms are unable to go direct to insurers due to the highly fragmented nature of their business – there are thousands of small auto rebuilders, dismantlers and dealers competing against each other, often limited by location. It is therefore unlikely buyers or sellers operating on auction platforms can collude to usurp the core marketplace.
Low relative and absolute leverage: Copart maintains a healthier operating model vs. IAA through majority ownership of the lots it operates and through maintaining little debt via revolving credit facility of $400m and no other long-term debt – operating lease liabilities are just $82m. Compare this to IAA which has $1.25bn worth of long-term borrowings via mix of senior notes and revolver with operating lease liabilities of $709m. Owning its lots is an advantage for Copart, as it provides financial flexibility when times get tough – and they inevitably always do.
Scale: Online marketplaces exhibit winner-take-all dynamics, similar to stock exchanges- the largest platform with the most buyers and sellers (liquidity) is more likely to attract incremental buyers and sellers, reinforcing its dominance. Buyers value breadth of choice and sellers value the ability to quickly shift their inventory with minimal friction at the right price. Copart’s total footprint is in excess of 10,000 acres across >200 permitted salvage facilities close to urban areas vs. IAA’s 7,700 acres across a similar number of sites. Copart’s larger size means that it can process greater volumes at a lower marginal cost, which has proven valuable in times of catastrophe where huge salvage volumes require swift processing. Furthermore, salvage sites require permits which are limited and costly to obtain. Incumbents therefore possess significant intangible assets in the form of permits and relationships with insurers in being able to efficiently move volumes when required. Smaller players or new entrants would face significant barriers to entry in attempting to replicate these assets.
Copart has a number of attractive growth drivers, which we believe bode well for the future of the company:
- End market growth trends: the US used vehicles market has grown steadily over time observing the Manheim US Used Vehicle Value Index, the average year-on-year percentage change has been 2.0% over the last 10 years. This is supported by the increase in average age of the US vehicle fleet, measured by the R.L. POLK Average Age of Total Light Vehicles Index, which has risen from an average age of 8.9 years in 2000 to 11.8 years in 2019. People holding on to their cars for longer creates greater demand for parts. Outside of recessionary periods, the number of vehicles sold per year in the US has averaged 15.1 million since 1976 and 16.0 million since 2000 which helps support end-demand for salvage and parts. In addition to underlying structural support for Copart’s end markets, the increased use of electrical components in vehicles together with increasing use of modular design techniques and higher labor costs for repair mean that insurers are more likely to write-off a vehicle involved in an accident than attempt repair.
- Developing dealer market: Copart is also hard at work in developing relationships with independent dealerships as an additional source of inventory, whilst simultaneously adding capacity in the second-hand market through providing an avenue for vehicles that run but are too damaged for dealers to handle. Copart’s sales to insurers account for 79% of sales today with 21% going to dealers, banks, finance companies, fleet operators and charities. Notably the non-insurance business grew at 20.6% year-on-year as per management’s comments from their Q2 2020 earnings call.
- International expansion: an increasing amount of Copart’s business is coming from outside the US, with international sales representing 18.9% of the FY 2019 total and 17.6% of FY 2017 total. Germany represents a significant opportunity and could serve as a springboard for other markets, particularly in Western Europe which is a potential market size equal to that of the US today of $1.66bn. In Europe, once a car is totaled and insurance claim paid, the onus for selling the car falls on the vehicle owner, therefore work is required to get insurers to see the value of operating under a US style fee-based auction model. We expect this to accelerate in Western Europe due to the greater efficiency of the auction model and intensification of insurance competition in Europe, particularly amidst negative bond yields putting pressure on insurer profits.
Is Copart’s Price Fair?
Optically, Copart does not look cheap, it currently trades at a Price to Earnings of >25x however readers should be reminded of what they get for this price. We perform a 2-stage Discounted Cash Flow analysis of Copart shown in Table 4 below. We assume a 10% revenue CAGR over the next 10-years noting revenue growth has averaged nearer 16% over the last 5 years and factors in the company’s expansion into Western Europe. Our terminal assumptions include a 35% operating margin with a beta of 1 and a terminal growth rate of 2.0% equal to long-term expectations of GDP growth (note, the business cannot grow faster than this forever).
We arrive at a fair value of $90 per share representing about 20% upside and therefore recommend it as a buy. Note that if the business surprises on any of our core assumptions, this assessment of fair value will shift.
Disclosure: I am/we are long CPRT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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