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Published by Thomas Kennedy

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Published by: Thomas Kennedy on Dec 28, 2010
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Copart Analysis - December 2010 Thesis:Copart is a leading provider of auctions for salvage vehicles. This niche of the vehicle auction industry is heavily consolidated with Copart and KAR AuctionServices (KAR) comprising over 70% of the market. Copart is able to earn a highreturn on investment because auctions have natural competitive advantages.Buyers and sellers will be attracted to the largest auctions as it provides sellers thelargest audience of buyers and gives buyers the largest selection. This makes itdifficult for new competitors to enter the market as it is difficult to take buyers andsellers from previously established auctions. Copart has been able to grow byacquiring smaller competitors and through internal expansion. Because themajority of salvage vehicles aren’t sold through auction, Copart and IAAI have thepotential to increase the size of the market by targeting new segments of sellers. Itis also expected that the annual number of salvage vehicles will increase; certainfeatures on new cars increase the costs of repairs, increasing the likelihood adamaged vehicle is considered a total loss. Their strong business model and growthopportunities make Copart a strong candidate for a long term investment.Investment Summary:Since 2000, Copart has grown their revenues and earnings per share (EPS) by13.4% and 17.2%, respectively, on a compounded annual basis (see Fig. 1). Theseresults reflect an increase in margins and proceeds per vehicle from the company’smove to online auction format which has buoyed past results. Results since thisshift in 2004 have been impressive as well with revenue and EPS growing by 9.3%and 12.8%, respectively (note: UK revenues are net of the cost of vehicles sold toimprove comparability). With their current growth prospects the company has the
ability to sustain strong growth, although acquisitions will add variability to futureresults.Relative to their past valuation, Copart is priced relatively low, but withinhistoric ranges for price to earnings, price to book and enterprise value to EBITDAvalues. Despite periods of volatility share price has tracked EPS relatively closely(see Fig. 2). On an absolute basis Copart seems to be priced at a fair value. Thecompany’s price implies free cash flow growth of 7% for the first 10 years and 3.5%growth in perpetuity, which seems realistic. There is added risk to an investment inCopart as there is no currently no margin of safety, but investors would be wise tokeep the company on their radar.Industry Summary: The secondary market for automobiles is robust. There are sales betweenconsumers, sales or trade-ins of vehicles with dealers and a number of behind-the-scenes transactions. During its useful life a vehicle can move between dealers,consumers, rental companies, body shops, wholesalers, exporters, financialcompanies, and other parties. The beginning of a cars life revolves around theconsumer with other industry participants helping bring supply to where there isdemand. Sales where the consumer is involved are often direct sales whereasbehind-the-scenes transactions will often be an auction format.When a vehicle is badly damaged, whether from accident or wear and tear, itenters the salvage market. The seller could be any of the users listed above or aninsurance company, who will often take possession of their customer’s totaledvehicle. The buyer will often depend on the condition of the automobile. When it’seconomical to make repairs a rebuilder or repair licensee will often be thepurchaser; when repairs don’t make sense a dismantler will purchase the auto forparts. Most sales are made directly between parties but auctions represent ameaningful percentage of sales, especially for sales by insurance companies. Whena vehicle is repaired it will reenter the used vehicle market. A dismantled vehiclewill have high value parts sold to the automotive parts market and low value ordamaged parts will be recycled.Competitive Analysis:Copart is one of the leading providers of vehicle auction services. Theauction environment is heavily consolidated both for salvage and whole (non-salvage) vehicles. There are three primary competitors, Copart, KAR AuctionServices (KAR) and Manheim, which control a majority of the market. In the wholecar segment Manheim and KAR control roughly 50% and 21% of the market,respectively and no other competitor represents more than 3%. The salvagemarket is held jointly by Copart and KAR holding 37% and 35% market share,respectively, and no competitor comprising over 10% of the market. These market
leaders should be able to grow faster than the market through a combination of internal growth and the acquisition of smaller competitors.Roughly 9-10 million and 3.5 million whole and salvage vehicles, respectively,are auctioned each year. These numbers are fairly stable compared to new carsales as they are influenced more by the number of vehicles on the road thanconsumer spending. The number of vehicles in the United States is estimated tohave grown from 209.5 million in 1999 to 248 million in 2009, a compoundedannual growth rate of approximately 1.7%. The long-term growth of whole carsauctioned should mirror this growth. The total volume of salvage auctions should experience growth beyond thenumber of cars on the road because of an increased incidence of cars totaled andfrom auctions gaining market share over direct sales. Features on new vehicleshave made repairs more expensive. This has caused an increase in the percentageof accidents resulting in a total loss, increasing salvage volumes as a result. Thereis also room for salvage auctions to gain market share as only 3.5 million of the 12million de-registered automobiles are brought to auction each year. Most of thismarket share growth will be outside the insurance industry which is currently thelargest contributor to salvaged auto supply.Aside from growth in vehicles sold, the industry has historically been able togrow average revenue per unit. Pricing naturally grows with inflation, as revenue isoften tied to the cost of vehicle. Industry leaders have also done a good job of passing on general price increases. All of these factors have helped the industryexperience steady growth.Company Overview:Copart is well positioned within the vehicle remarketing services industry. They transitioned from traditional, on-site auctions to an online only format in 2004. This move has helped to improve margins considerably, with EBITDA margins goingfrom the low 30’s to the low 40’s. Another testament to the success of their onlinemodel is that for US sellers 25.3% of vehicles were sold out-of-state and 21.5% weresold outside the country. By being able to bring vehicles to a larger audience,sellers realize higher pricing giving Copart an advantage over smaller competitors. The vast majority of Copart’s revenue is through the auction of salvagevehicles. Auction revenues represent fees charged to both the buyer and the seller;possession of the car is transferred directly from buyer to seller. Operations in theUK are different as Copart buys and takes possession of the vehicle before it isresold. To make results comparable these revenues are net of cost of vehicles,which is more comparable to the fees which are received in US operations.Copart has recently begun initiatives to expand their vehicle sellers outside of insurance companies, which currently account for approximately 83% of vehicles

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