Copart - A Quality Market Leader with Competent Management and Great Asset Allocation
<4 min read
Business Overview & Business Model
Copart has been a strong performer over the last decade, more than doubling the returns of Nasdaq and quadrupling the returns of the S&P. The company operates in an unsexy and boring industry, they own valuable real estate in metropolitan areas, and their competition is weak. Copart operates an online auction platform and several scrapyards worldwide. Let’s take a look at the business.
Copart operates an online car auction website. It is the largest platform in the market with approximately 265k vehicles in total.
The business operates several scrap yards in metropolitan areas where it salvages car parts from cars that are not worth repairing. One important advantage Copart has is that it owns the real estate on which its salvage yards operate. This gives them better margins than their competitors that rent the land.
Copart has built relationships and trusts with several of the biggest insurance companies. In practice, this means that when an insurer gets a case with a crashed car, Copart will provide an estimate of the cost of repairs and will buy the salvaged car if the repair costs are higher than the cost of salvaging the car.
According to IAA, which is Copart’s biggest competitor, the used vehicle market will expand by 2 million vehicles per year.
Cars have increased lifespans and vehicle complexity increases the likelihood of salvaging cars. This is primarily because increased complexity means increased cost of repairing the vehicles. The salvaging number has gone from 8.5% in 2010 to 20% in 2020 reflecting the increased complexity.
Copart is the market leader and has a market share of 40%. The second largest player is IAA. IAA is set to merge with Ritchie Brothers. This merger is questionable from investors, as it increases Ritchie Brothers’ leverage, and the synergy is questionable. Copart is the clear market leader with unique assets and a strong competitive position. IAA is not a big threat and it is unlikely for new entrants to enter this space, given the competitive situation. This leaves Copart in a very favorable spot, where it probably will continue to grow for the next decade plus.
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The founder of Copart, Willis Johnson owns ~7% of the company. Johnson has stepped down as CEO, but his family continues to run it. The current CEO is Jay Adair. Adair is Johnson’s son-in-law and is married to his daughter. Adair began his career in 1989 and was promoted to CEO in 2010. He owns around ~4% of the company. The CEO has a salary of $1 plus equity, this means that management and shareholder values are aligned. As we know, owner-operator businesses and businesses where the management has skin in the game provide superior returns for shareholders.
The management is also a long-term thinker. Adair talks about the next 40 years, as opposed to the next few quarters, which is the focus of Wall Street. This is also a trait to look for when evaluating management.
The results speak for themselves, Adair has outperformed both Nasdaq and S&P500 since he took over as CEO and he will continue to do so in the future. The management performance is reflected in their return on capital numbers:
Buybacks and Capital Allocation
Another sign of great management is capital allocation. Knowing when to buy back stocks, when to pay dividends, do M&A, or pay down debt is a key management skill that translates into shareholder value.
Copart has bought back shares in times when the business has been a buy. When they determine that the stock is cheap compared to the future outlooks and current valuations, the management buys back huge quantities of the stock.
In 2011 Copart bought back 29% of shares outstanding - Copart had a PE of 0.6 vs. the S&P in 2011.
In 2016 Copart bought back 12% of shares outstanding - Copart had a PE of 0.4 vs. the S&P in 2016.
These two buyback sequences have been an amazing investment for Copart and show management competency.
Balance sheet and financial health
Copart has a very healthy balance sheet, they won’t go bankrupt in the foreseeable future. Their net cash position of over $1BN and high levels of free cash flows can support the business for years. Copart’s debt to free cash flow is 1.09, meaning that Copart could pay off all debts with less than 1 year’s worth of free cash flow.
Market cap: 29.8BN
Operating Margin: 38%
Gross Margin: 44%
Cash Conversion: 75%
Interest coverage: 81x
Compounded Annual Growth Rates:
The company has produced high levels of growth in earnings, revenues, and cash flows. It does however look like growth is slowing down from the YOY numbers.
Barriers to entry
Scale - You need sufficient scale to compete. To achieve the scale you can build up your reputation over the years as Copart has, or you can try to buy your way into the market - hard to do and likely to fail.
Relationships & Trust - 80% of listings come from insurance companies that Copart has built a relationship with for decades. Trust is an underrated variable in markets.
Real estate - needed near all major metropolitan areas. This will cost a ton to invest in upfront, or it will hurt your margins significantly if you choose to rent the land like IAA.
Intangible assets: Website/Platform
Network effects: The more insurance companies and consumers that use their platform increases the efficiency of the platform. It provides better products for the consumer, and it provides more data points for Copart to increase the effectiveness of the platform.
Valuation - Discounted Cash Flow Analysis
If we compare Coparts free cash flow yield to the risk-free rate, we get the following:
FCF Yield 1.87%
Risk-free rate: ~4%
Comment: FCF Yield is more than 2% below the risk-free rate. However, it is growing at a +15% pa rate. This is a very steep valuation.
Using a simple DCF model, with the following inputs (Black cells):
Using the FCF from TTM of $792MN and 3 different scenarios, we receive a fair value estimate of $30.14 billion. That is a discount of 28.6% from today’s levels of $42.22 billion. In other words, at the current valuation, Copart appears to be overvalued for my requirement. I’m expecting Copart to return somewhere in the 6-9% annual range. However, this will depend on their ability to continue to grow and compound.
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Copart is a High-quality business with a great management team that is aligned with its shareholders to provide value. The management has a proven track record of being great capital allocators, they hold a high level of the shares, they have managed Copart into a market leader with a 40% market share and a strong market position, and they talk 40 years in the future. All signs of a great management team.
The business has a wide moat in barriers to entry, intangible assets, and network effects. The main competitor IAA is unlikely to provide much trouble for Copart as it has merged with Ritchie Brothers. It is expected that the merger will give the company plenty of hurdles to overcome and a company with a split focus might not pose a big threat in the years to come.
Copart is currently highly rated, it is trading near an all-time high on several multiples. The FCF yield of 1.87% is very low, as we don’t expect Copart to be able to grow at 20% annually moving forward. A more modest growth profile of 12-16% results in a fair estimate of 28% below the current market cap.
That said, Copart checks all my boxes for a fantastic business, but at the moment I don’t see it as a good entry into the company. I’m patiently waiting for this to meet my hurdle rates, as I would love to own it at some point.
This is a modified repost, I did a write-up on Copart in early Q1, but I have more than 2,000 new subscribers since then.
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