Copart is a global provider of online auctions and vehicle remarketing solutions. The company provides secondhand vehicle sellers with a full range of services to process and sell vehicles through its online auction platform – VB3.
Copart’s largest customer is insurance companies. An accident or related event will cause an insurer to write off their customer’s vehicle. Once written off and the policy has paid out, Copart steps in. Insurers will list the totaled vehicle on VB3 to recoup some of the losses incurred. For an additional fee, Copart will handle storage, transportation, title processing, and preparation of the vehicle.
Copart runs an agency model. Instead of buying the vehicle outright from the insurer, Copart only lists the vehicle on its platform and takes a fixed percentage of the sale value. The company used to be a principal buyer of vehicles, however, this model operated at lower margins and tied up capital.
Competitive Environment
Copart has reached a level of scale that makes insurers highly reliant on its services. As Founder Willis Johnson says – “We are like the septic tanks of the sewer system. You can’t have the system without us.”
Insurance companies send their totaled vehicles to Copart because they know Copart has the largest network of dismantlers, dealers, and other buyers. Buyers are drawn to VB3 because it has the largest selection of cars for sale. High auction liquidity ensures the sellers will get fair market value. Additionally, Copart’s wide physical presence provides insurers with the quickest assessment-to-sale timeline.
Copart owns 267 storage yards for totaled vehicles globally. This equates to more than 2x the land owned by its two largest competitors combined. The group also has a large fleet of transport trucks. This fleet and yard combination gives Copart the ability to pick up, store, and list vehicles (for most of their insurance clients) within 24 hours.
The combination of Copart’s significant fixed capital base, coupled with its efficient online platform provides it with both economies of scale and network effects.
These two competitive advantages underpin Copart’s high returns on invested capital and ensure its competitive position is entrenched.
For a competitor to replicate Copart’s business model would require a significant amount of capital and a differentiated product to lure insurers away from VB3.
Structural Tailwinds
Damaged vehicles are inspected by the insurance company’s adjuster, who estimates the costs of repairing the vehicle. The adjuster gathers information regarding the damaged vehicle’s mileage, options, and condition to estimate its pre-accident value (PAV), otherwise known as actual cash value. If the cost of repair is greater than the PAV less the estimated salvage value, the insurance company generally will classify the vehicle as a total loss.
Annual total loss frequency (TLF) is the number of vehicles totaled as a percentage of those assessed. Over the last four decades, there has been a steady rise in TLF. TLF today is ~20%, up 16 percentage points from the 1980s.
Upgrades are making newer vehicles more costly to repair and, accordingly, more likely to be deemed a total loss for insurance purposes.
Upgrades include unibody construction utilizing exotic metals, passenger safety cages with surrounding crumple zones to absorb impacts, plastic and ceramic components, airbags, adaptive headlights, computer systems, advanced cameras, collision warning systems, and navigation systems.
Even a minute amount of damage to a digitized vehicle may warrant an insurer to deem it totaled.
Electrification is similarly going to make insurers write off more damaged vehicles due to a combination of more advanced technology and the absence of repair networks. Morningstar and IHS Services estimate that 67% and 63% of vehicles sold in 2030 will be electric, respectively. A higher proportion of totaled vehicles benefits Copart’s auction pricing and volume. Greater TLF increases yard throughput while the quality of (deemed “totaled”) vehicles is rising, bringing in higher selling prices during the auction.
COVID Impact
Copart started assessing damaged vehicles on behalf of insurers because they wanted to avoid in-person engagement with their clients. This new service offering has been further supported by labour shortages at insurers.
The pandemic also brought a momentary pause to the upward trend in TLF. Supply chain disruptions constrained original equipment manufacturers’ ability to produce new vehicles. A decline in new vehicle supply subsequently led to a significant rise in used vehicle prices.
Used vehicle prices inform pre-accident values, so insurers began to total fewer vehicles because it was cheaper for them to pay for repairs.
Higher used vehicle prices have constrained Copart’s auction volume in two ways. The decline in TLF has reduced auction throughput, while higher listing values have priced out potential buyers.
Luckily, Copart’s operating model is naturally hedged against both high and low used vehicle price environments. Higher used vehicle prices negatively impact volume but lead to higher auction average selling prices (ASP).
Copart’s revenue momentum has been unaffected by new vehicle shortages as lower volumes have been more than offset by higher ASPs. Going forward, a moderation in used vehicle prices will invariably impact Copart’s auction ASPs but will also increase TLF and auction volume.
Social Impact
Copart provides two vital services to society. Vehicle recycling and catastrophe assistance.
The company is estimated to save 100x the carbon dioxide that it emits itself. This is due to its participation in the recycling of vehicles.
Many of the vehicles that Copart auctions are in drivable condition. These vehicles are primarily purchased by foreign buyers in emerging markets. Roadworthy tests in emerging markets are less stringent than in developed markets, so a vehicle that is deemed unroadworthy in the US might find itself on the road in Brazil.
Dismantlers also represent a large base of Copart’s customers. These buyers will resell dismantled vehicles for parts, components, or scrap.
Copart has increasingly become a major participant in US disaster recovery efforts. Hurricane Katrina was the company’s first natural disaster project. Between 2005 and 2006, Copart processed more than 10 000 vehicles that were damaged by the hurricane.
Since Katrina, the increasing frequency of catastrophes in the US has led management to shore up its disaster recovery capacity. Copart has acquired 1500 acres of land that is purposed solely for catastrophe storage. This represents more land than what one of Copart’s large competitors owns in its entirety.
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. In the first 10 days of the event, Copart retrieved over 15 000 vehicles, enabled by both its third-party subhauler network, as well as its company-owned tow trucks, transporters, loaders, and drivers. Copart recovered 70 000 vehicles through the end of October. All vehicles will be listed on Copart’s auction platform on behalf of insurers such as GEICO.
Outlook
Management has no intention of slowing down investment in the business. The company’s yard acquisition pipeline is significant for the next five years. Each new yard adds to auction liquidity – reinforcing the group’s flywheel.
Management chooses not to pay a dividend because the return on growth capital expenditure far exceeds the potential yield it can offer to shareholders.
The risk/reward trade-off for expanding the capital base is favourable as the vehicle salvage market will continue to benefit from long-term structural tailwinds. Improved efficiency in vehicle upgrade cycles and increases in repair costs will underpin the long-term supply of better vehicles. Insurers are also likely to outsource more services to vehicle auctioneers over time. Copart’s share price has come under pressure in 2022 – falling from its high of $78/share to as low as $50/share. The company has been on our watchlist for some time and the recent market volatility has provided us with an opportunity to gain exposure at a favourable valuation.