David Rolfe Comments on Copart

Copart (NASDAQ:CPRT) is the largest company in the automotive salvage and auction industry. The industry is a duopoly, with the Company commanding a +40% market share. Insurance Auto Auctions is the Company’s only competitor of size or scale. The Company generates about 80% of its revenue in the U.S. The other 20% is generated in international markets. The U.K. generates the lions share at 15%. The rest is spread out in newer markets that include Canada, Brazil, Ireland, Germany, Spain, the U.A.E., Bahrain, Finland and Ireland. Copart owns the largest global buying network, which essentially matches global demand with local supply.

The demand for salvage autos is a mix of dismantlers and rebuilders of used and refurbished auto parts that serve the auto repair market, whereby salvaged parts are considerably cheaper than new or OEM parts. Demand for autos that are damaged but worthy of repair has become a staple of international demand whereby repaired cars are not subject onerous safety regulations. With the Company’s advent of nationwide and global online salvage bidding additional demand for complete, drivable autos from used car dealers and individuals has become quite significant in the demand mix. Insurance companies processing totaled autos make up the bulk (+87%) of the supply of auctioned autos. Copart has long relationships with State Farm, Allstate, Nationwide, and Farmers. GEICO recently signed on, which could easily yield +130,000 autos per year in supply. Other supply parties include charities, banks, rental car companies, fleet operators, and auto dealers. Copart acts as an agent, earning fees from both buyers and sellers.

For decades the industry has been a rough-and-tumble affair dominated by local mom-and-pop barbed-wire salvage yard owners serving local, state, and regional northeastern markets. That is until Copart entered the scene. Copart was founded in Northern California in 1982 by born entrepreneur Willis Johnson. Johnson was in a hurry, but growth was slow during his first ten years. On the back of private loans, Johnson has acquired three more yards in Northern California. Recognizing the network and scale effects, plus the operational leverage of just a few additional salvage yards Johnson’s insatiable desire for growth could only be quenched by more yards. That took more money – a lot more money. Johnson took the Company public in 1994. The $27 million in fresh equity capital was quickly put to use. By March 1994 Copart added eight more yards and significantly expanded geographically with the purchase of North Texas Salvage Pool in Dallas, Texas. By 2004 Copart owned over 100 locations and was generating $400 million in annual revenues.

Arguably one of Johnson’s most significant strategic decisions was his very early use of information technology. As early as 1992 Johnson gave auto insurers online access to track salvage sales. These early technology initiatives led to the creation of Copart Auction System (CAS) in 1997, which allowed sellers access to a myriad of information. In 1998 Copart launched a true eBay-like internet-based auction system. The days of the traditional local, in-person salvage auctions were numbered. In 2003 the Company released VB-Squared, which opened up the auction process to registered buyers and sellers on a global basis.

In 2010 Johnson passed on the role of CEO to his son-in-law Jayson Adair, who has been an executive with the Company since 1989.

Fast-forwarding to the current decade of unabated growth, Copart reached the 10 million auction unit milestone and built network capacity in the U.S. and U.K. of over 500,000 autos by 2012. When Hurricane Sandy hit on the eve of Thanksgiving that year the Company was tested as never before. Hurricane Sandy affected 24 states, including the entire Eastern seaboard from Florida to Maine, up west across the Appalachian Mountains, and finally to Wisconsin and Michigan. Severe damage even went as far as New York and New Jersey. Copart employees worked 60 straight days – including Thanksgiving. Some 325 Company employees outfitted with 575 car transporters worked around the clock. In 90 days, the Company picked up over 85,000 cars – more than during a given year at the time. At its peak, the Company picked up 2,300 autos in a single day. The damaged autos would consume 11 acres of storage per day.

2013 brought the acquisition of Quad Cities Salvage Auctions and Desert View Auto Auctions (donation vehicles for charities). VB-cubed rolled out. The new auction platform now included non-members and expanded the buyer base. Auction attendance was up sharply +48% for the year. The Company launched its mobile app on iPhone and iPad. The bidding on the new app grew quickly to 10% of all bidding. By the next year, mobile auction attendance more than tripled (+214%), and mobile made up +23% of all auction attendance. By 2016, 19% of winning bids came from mobile and the mobile app would be downloaded in nearly 200 countries.

On the international front, 2013 saw the expansion into Brazil, Spain, Dubai, and Germany. 2014 saw 400,000 new registered members globally. 2015 witnessed significant growth in Germany and Spain and expansions in both Oman and Bahrain. By the end of 2015 the Company operated 175 locations worldwide, including 25 outside of the U.S. Auctions went live in Germany and Spain during 2016.

Over the past five years, physical inventory more than doubled to over 200 yards, covering 9,000 acres. The Company’s capex continues to accelerate to three times its 10-year average. Today the Company operates 200 yards with over 9,500 acres. On a typical day the Company has around 200,000 vehicles for sale on its auction website. Today, about 50% of all auction cars are sold inside of state yards, 30% are sold across state lines and 20% are sold outside the U.S. According to the Company, 75% of all U.S. based auctions receive a bid from an international buyer.

Scrap and salvage yards have long possessed the classic not-in-my-backyard competitive advantages. Over the years more stringent local, state, and federal regulations have served to amp up NIMBY attributes. As mentioned, Willis Johnson early-on saw firsthand the economic benefits of local network effects of size and scale in terms of growth and profitability. The network scaling leap from local, to state, to nationwide, and ultimately international, via both hard-asset raw land and a huge fleet of transporters, plus captive insurance companies totaling a greater proportion of accident-damaged autos, combined with technological assets of best-in-class internet-mobile auction sites, has produced manifold operating leverage. To wit, over the past decade, the Company’s average revenue per location has increased over +50% – $7.1 million vs. $4.6 million and average net income per location has soared 150% – $2.0 million vs. $.79 million.

As 2020 clocks in, Copart is riding a wave of both company specific growth drivers, plus industry-specific drivers. On the industry front, Copart’s supply of prospective auctioned and salvaged vehicles continues to be robust due to the rise of accident frequencies due to the combination of aging vehicles (almost 12 years on average), increasing driver distractions (smartphones), and rising miles driven (at least in most geographies). In addition, the rising complexity of new autos, particularly since 2014, has resulted in a marked increase in the frequency in total losses from insurance companies. Think of your current newer car as a series of a few dozen small computers (some connected to each other) and related perimeter sensors and cameras fastened upon four rubber tires. In addition, new technologies like LIDAR – a laser/wavelength surveying method and detection that measures distance to a target by illuminating the target with pulsed-laser light and measuring the reflected pulses with a sensor used to make digital 3-D representations of the approaching target – will become standard technologies in the near years, along with related self-driving enhancements.

Even seemingly minor fender benders have become prohibitively expensive to repair due to a wicked combination of expensive electronic parts replacement, the growing time needed to make such repairs and related cost of insurance plan rental coverage, and the lack of mechanics and auto technicians with the necessary expertise. The resultant lumpy increase in the average selling prices of salvages autos has been a boon to the Company’s bottom-line. Such trends will likely never abate and will likely get worse as EV vehicles become mainstream. (Ask a Tesla owner how long it takes a certified mechanic to repair even a small dent in their car and ask them too how much their insurance coverage has soared over the past few years.) According to Copart, autos totaled by the insurance industry, which had flat-lined at around 14% of total claims have charted a new path upward each year since 2014 and have now reached 20% of total claims.

(A technological aside: According to Tony Seba (author and entrepreneur) at his recent presentation at the Robin Hood conference, Google early on estimated that its LIDAR system, which originally cost $150,000 to build, would cost just $70,000 by 2012. At the time. industry watchers and analysts sneered at Google’s estimate. Google proved itself correct. Its LIDAR systems’ cost in 2012 did indeed fall to just $70,000. Remarkably still, in just 12 months’ time that same equipment cost $10,000. One year later in 2014 the cost dropped sharply to just $1,000 – and then three years later to just $250! Seba also noted that as recently as 2000, a top computer used for nuclear warfare simulations had a capacity of 1 teraflop (1 trillion floating point operations per second), cost $46 million, used 850 kilowatts of energy, and took up 1,600 square feet. By 2017, Nvidia had developed a 2.3 teraflop computer that cost $59, used 15 watts of energy, and was small enough to fit in your pocket.

The combo of both company-specific operating levers, plus booming industry-specific fundamentals has manifested itself in the Company’s impressive profitability and growth. Over the past five fiscal years (July), the Company’s return on assets and return on profitability have doubled to 26% and 31%, respectively. Over the same period, annual revenues have almost doubled to just over $2 billion and earnings per share has nearly tripled. In the latest fiscal first quarter of 2020, the Company reported the second consecutive quarter of +20% auction revenue, the fifth consecutive quarter beating consensus EPS expectations and the third consecutive quarter of double-digit U.S. revenue-per-unit growth.

From David Rolfe (Trades, Portfolio)'s Wedgewood Funds fourth-quarter 2019 shareholder letter.

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