Description

Summary

We believe that Copart offers an attractive risk-reward at current levels and is in the early stages of a sustainable multi-year acceleration in volumes, Revenue, EPS, and FCF growth.

We have followed Copart for many years and invested in the company after it announced it was tendering for ~12% of its outstanding shares (it attempted to buy back shares first this past June between $34.75 - $36.00 per share and after only filling half the tender, the company followed up with another tender this past November between $38.00 - $41.00 per share, a 14% premium at the high end relative to the first tender).  Insiders, who own approximately a quarter of the company, did not tender any shares.  The company has been a serial repurchaser of its stock over the last two decades as a public company and has created tremendous shareholder value, compounding at over 16% since its 1994 IPO.  Copart first tendered for stock in early 2011 and the stock subsequently doubled in the following two years.  We also expect strong price appreciation this time, as we discuss below.

Overview

Copart conducts auctions for totaled cars and collects fees from both buyers and sellers for its services.  The company operates as the leader in the salvage auction market along with Insurance Auto Auctions, “IAA”, a subsidiary of KAR Auction Services (KAR).  The salvage market is very stable and largely immune to economic impacts, growing historically in the low single digit range.  The business has significant operating leverage because the majority of its costs, primarily land, are fixed.  Copart does not incur inventory risk because it auctions most cars on an agency basis.  This business has very high barriers to entry and is nearly impossible to recreate because of zoning and permitting restrictions.  These factors allow the company to generate EBITDA margins in the 35-40% range, returns on capital of 15-20%, and significant free cash flow that has historically been used to grow the company and buy back stock.

For additional detail on the company, the salvage industry as well as industry drivers we encourage you to review Copart’s April 2016 Information Supplement (the only public presentation we’re aware of since Copart went public) or any of KAR’s Investor Presentations.

Drivers

Because management does not discuss its outlook for the business in detail or provide guidance, our extensive field research has been particularly useful to help us understand the current end-markets and make a few interesting discoveries.  First, Copart’s yard inventory is a leading indicator of sales and is up approximately 10% in the last year, due to rising industry volumes and a recent market share win.  Two factors are driving scrap volume growth: an increase in accidents and an increase in the percentage of accidents that result in totaled vehicles.  In terms of accident rates, the causes include growth in miles driven, rising average age of vehicles on the road, and more distracted drivers.  As for the higher percentage of totals, the main culprit is the increasing amount of technology costs embedded in cars.

We have also discovered that Copart initiated a large price increase last summer on the buy-side of its auctions, which was the first such increase in the last 2-3 years.  We estimate that this increase will add 5% to Copart’s revenue without impacting volumes, flowing straight through to the Company’s bottom line.

We believe these positive factors will lead to earnings upside over coming quarters; the first of which was already seen in the Company’s most recent quarter with an 8% top-line and 12% bottom-line beat.  These beats should become more meaningful in coming quarters as Copart laps the biggest moves in the U.S. dollar and scrap metal prices last year (both of which have reduced the revenue and profitability per vehicle sold), the benefit of its recent win for the remaining ~60% of the Farmers insurance business it didn’t already have, and from additional growth as Copart adds 20%+ capacity in the U.S. over the next two years, and builds out its international footprint.

Earnings Power

We believe that Copart can earn over $2.10 per share in FY16 ending July, or ~10% above current Street estimates, and can earn closer to $3.00 per share in FY17, or ~40% above current Street estimates.  

Valuation

At its current price, Copart’s stock is trading below the high end of its November 2015 tender offer and not too far off from the $35.62 exercise price of options granted to the Company’s top executives (and account for substantially all of their compensation), which we believe is a floor for the stock price.  We believe that Copart is worth $60+ within two years applying an 18x multiple on FY17 EPS plus the cash generated in the interim, or ~50% upside from today’s levels.

Additional Upside

There are a number of potential call options that could expand Copart’s business meaningfully:

• Non-insurance: increased penetration of vehicles that are removed from operation but don’t make it to salvage yards

• International Markets: ability for Copart to replicate North American success in other countries, namely Western Europe which could more than double volume, revenue, profitability, cash flow

• Real Estate: other uses for real estate (REIT, broaden use beyond salvage, etc.)

• Technology: leverage technology for other uses (i.e. Internet auction platform could be used to facilitate other kinds of auctions outside of salvage vehicles)

Risks

• Continued exogenous factors like a strong U.S. Dollar and weak scrap metal prices

• Irrational competitive environment – IAA attempts to undercut Copart on price

• Execution risk as Copart expands internationally

Catalyst

Catalysts

• Q316 results: should demonstrate another strong beat

• Domestic expansion including 20 new yards and 20 expansions over the next 20 months

• International expansion and scale in to new markets

• Increased disclosure, more transparency