Copart Stock: How Much Of Its Growth Is Already Priced In? (NASDAQ:CPRT)

Investment Thesis

Since March 1994, when Copart (NASDAQ:CPRT) was listed in Nasdaq, the company has “rewarded” its shareholders with an incredible 24.000% return approximately. Even though we don’t believe that this kind of returns will be replicated in the future, Copart is expected to continue generating decent ones. The company possesses an impenetrable moat and the auto salvage industry is experiencing favourable tailwinds. Moreover CPRT has a recession-resistant business model and an extremely healthy balance sheet. But all the above come at a cost. The company’s shares are trading at a rich valuation and as we will show in our analysis, Copart’s future growth is already more than priced in. The main risk for the company in the long run is the advent of autonomous driving. We rate the stock as a “Hold” with a price target of 51.24 USD.

A Formidable Moat

Analyzing Copart without mentioning a few words about its moat would be a deadly sin. The company possesses a well-entrenched moat which is comprised of network effects and scale economies. Without further ado, let’s deep dive into them.

The company’s network effects stem from its online auction platform which was launched back in 2003. Having realised early that online auctions was a one way street, due to the fragmented nature of the auto salvage industry, Copart was a pioneer in the transition from physical to online marketplace. Currently the company’s online platform is by far the largest around the globe with online presence in more than 170 countries and 750,000 subscribers. The more buyers a company attracts to its platform the more valuable becomes for sellers and vice versa. Sellers are able to achieve higher bids and buyers to find what they are looking for more easily. Replicating Copart’s network is not an easy task especially for new entrants.

Copart’s economies of scale are based on its more than 243 privately-owned salvage yards in a global level. The company invested a significant amount of both capital and time in order to build this network. It is worth mentioning that in the case of its new yard in LA it took Copart decades before managing to find a space there in FY17. Its management recognised very early the importance of land acquisition so it never stopped investing on it. It is particularly important for Copart to operate a dense network of yards all over the USA in order to be able to serve efficiently the large insurers which are its biggest clients. Currently the company can pick up a vehicle within 1 day. Moreover, a vast network of salvage yards helps the company reduce its average cost of towing, which is its most important cost factor.

On top of that, the company is also benefited from the existence of the “Not in My Back Yard” or NIMBY phenomenon. This simply describes the opposition of local residents to the development of a yard in their area due to health concerns associated with harmful materials and toxic fluids. Thus a new entrant will face serious problems finding a suitable place since the best ones are most probably already taken and residents could argue that salvage needs are already being taken care by existing salvage areas.

To sum up, a new entrant would need at least (1) vast amounts of money in order to be able to buy or lease a sizeable network of yards, (2) to sign contract with insurance agencies (3) attract buyers on his platform (4) getting the necessary permits and (5) to manage to do the above without running out of cash. Definitely not a piece of cake!

Last but not least a closer look at the below chart will persuade even the most distrustful person about the strength of Copart’s moat.

Key Demand Drivers

In order to assess the company’s growth prospects we will analyze the key factors that drive the demand for Copart’s services. These are miles driven, accidents per mile and salvage rates. So let’s deep dive into them!

As anyone can imagine when more miles are being driven the likelihood of an accident increases. We assume here that the accident per mile remains fixed. In general the growth rate of total miles driven per year follows closely the respective rate for population. Hence we assume an increase in miles driven between 0.5% to 1.5% per year. In case of a recession they are expected to fall or stay the same at best.

In the long run the secular trends of working from home and ridesharing most probably will affect negatively the number of miles driven. In conclusion this is more or less a predictable demand driver that is not expected to take investors by surprise.

On the front of accident rates now, things are moving in a rather counterintuitive way. The majority of people would argue that the crash rates are decreasing due to the significant improvements in safety technology. Unfortunately this is not the case. Car accidents have been on the rise since 2011 due to reckless driving. One aspect of this behavior is the extensive use of smartphones while driving. Another, more subtle one is a phenomenon called ” Risk Homeostasis” which states that “people at any moment of time compare the amount of risk they perceive with their target level of risk and will adjust their behavior in an attempt to eliminate any discrepancies between the two”. In other words since people feel safer due to technology they drive more carelessly.

Hence, a material drop in accident rates is not expected in the short to medium term. In the long term everything comes down to the development and adoption of autonomous driving technologies.

In contrast with the two aforementioned factors, salvage rates were on the rise during the last decade. This trend could primarily attributed to 3 main subfactors. First of all we should mention the consolidation that is taking place in the auto repair industry. The market is dominated by the top 3 players. From 65,000 collision repair businesses in 1980, today operate only 32,000. This situation has provided excessive pricing power to these 3 multiple repair store operators which has increased the average repair cost.

In addition the increased complexity of new cars which incorporate a large number of technologically advanced components and electronic systems, makes things worse. So even in less severe crashes it makes more sense to total the vehicle rather than repair it. In accordance with Copart’s CEO Aaron Adair nowadays 20% of cars are deemed total losses after a crash. The respective % before four decades was just 10%. In the long run many analysts expect this ratio to gradually rise to 50% as newer state-of-the-art cars enter car parcs.

Last but not least, the average car parc in USA is steadily becoming older since the Global Financial Crisis. According to Copart’s data, vehicles more than 7 years old are 2.5 times more possible to be totaled than cars with an age of less than 7 years.

A Recession Resistant Business

So far so good, but how Copart behaves in the case of a recession?

This seems to be another one strong point for the company -particularly appealing to conservative investors- as it has been proved to be “recession-resistant”. In a typical recession miles driven go down but usually not very much as the GFC has shown. Back then the total miles driven decreased only by approximately 3%. Accident rates remain stable but the salvage rate goes up as the repair cost as a % of the pre-accident value (PAV) increases. As a result, insurers choose to write off more cars. Moreover, during recessions Copart usually gains market share due to the fact that small players in the industry go bankrupt or are “forced” to sell their businesses to CPRT.

But what happens with the average revenue per vehicle?

This metric is affected by the used vehicles prices. During GFC auction values went down by 15%. However, Copart exercising its pricing power managed to almost completely offset this development. Its revenues from the services segment were decreased only by 1%. If we take into account also its car sales business still Copart’s sales decreased only by a meager 5% between 2008-2009. In the course of a supply-induced crisis like COVID-19 the company’s car sales segment came to the rescue. Higher prices helped the company overcome the crisis unscathed.

Financial Analysis

Now let’s try to assess Copart from a financial perspective. First things first, we will try to determine the healthiness of its balance sheet with the help of 3 key metrics. The first of them , interest coverage, is not even defined since for the last 12 months the company didn’t pay any interest. On the contrary it earned around 113 million USD as income from interest and investments. Furthermore, the company has a net cash position of 2,55 billion USD with cash on balance sheet to account for approximately 5% of its market cap.

Lastly, Copart’s Goodwill/Assets ratio hovers at 6.72%. Overall the company has an extremely healthy balance sheet with plenty of cash and insignificant amount of goodwill.

Moving forward let’s have a look at how much capital does the company need in order to operate smoothly. Copart’s CAPEX LTM was approximately 525.6 million USD and its operating cash flow 1,401.4 million USD. Hence the company’s CAPEX/OCF hovers at 37.51%. The ratio looks pretty high. It seems that CPRT needs a lot of capital in order to operate.

But wait a minute!

The company invests heavily so it would make sense to break CAPEX in two parts, maintenance CAPEX and growth CAPEX and take into account only the former. Investments in future growth undercut current FCF but they will result in increased future FCF. In order to account for this we assume maintenance CAPEX to be equal to D&A. Hence taking into account only the D&A expenses of 163.2 million USD we arrive at a CAPEX/OCF ratio of 11.65% which looks way better. In general we prefer this ratio to be < 25%.

Finally, let’s examine Copart’s management ability to allocate its capital in an efficient and productive way. In order to accomplish this task we will have a look at the company’s ROA, ROE and ROIC.

Currently the respective numbers are 14.7%, 22.6% and 30.6%. Without any doubt the money of Copart’s shareholders is earning exceptional rates of return. As a rule of thumb we are looking for companies with ROIC > 15%.

Valuation

Quality comes at a price and Copart is not an exception to this rule. With a forward P/E of 38.76 it is not considered cheap for sure. We will use a Reverse DCF model in order to find out how much of the company’s future FCF growth is already priced in. Copart’s FCF LTM stands out at 856.2 million USD and its WACC is 7.92% We assume the company’s long-term growth rate to be 4.5% which is above the expected rate of inflation due to Copart’s pricing power. At the current price share of 56.27 USD the implied FCF growth rate for the next 5 years is 20.6%. According to analysts’ estimates the expected FCF growth rate for the same period is 18.1%. Hence Copart appears to be slightly overvalued. An 18.1% 5 year CAGR leads to an implied price of 51.24 USD which is our target price. A sensitivity analysis is also presented in order to help investors draw their own conclusions.

Risks

No investment comes without risk and a position in Copart’s stock doesn’t constitute an exception to this rule. Hence, current or potential shareholders should be aware of 3 main risks.

The elephant in the room here goes by the name of autonomous driving. At present the substantial improvements in safety features are being offset by reckless driving but a swift change to fully autonomous means of transport would certainly reduce crash rates dramatically. Such a development would render the company’s business obsolete. However, this is not an imminent threat but a long-term one. Driving is a pretty complex task and even if we had the required technology available today its adoption along with the creation of the essential infrastructure would take decades. But even then accident rates wouldn’t be completely eliminated. This time the main culprit could be IT failures and/or cyber attacks. On top of that many people are fond of driving and they are not willing to stop to drive. Some others simply don’t feel comfortable surrendering their safety to the “hands” of a computer. Lastly, a regulatory framework needs also to be developed and this won’t be easy due to ethical considerations.

The second risk has to do with the international expansion of the company and it is more of a short to medium term nature. Insurers in Europe and emerging markets follow a different claims process model. Besides, they are not used to take part in auctions on consignment. So the company has to convince them to change their business model which could prove to be difficult. As an alternative CPRT could purchase the totaled cars but this would require a lot of capital and would entail significant costs.

Last but not least, Copart is dependent on few large insurers on the supply side. If for any reason the company lose even one of these clients the damage could be proven irreversible. After all these large clients account for 80% of Copart’s supply of totaled cars.

Conclusion

Copart is a great company with a world-class moat and a really healthy balance sheet with minimal debt. Its capital allocation is exemplary. Moreover the company invests heavily on new yards in order to keep growing. On top of that the condition in the auto salvage industry is good too. Our main concern is the company’s hefty valuation. Hence we rate CPRT as a “HOLD” with a target price of 51.24 USD and a downside potential of 8.94%. We will reconsider our view when the risk/reward ratio will become more favorable.