Copart, Inc. (CPRT) – The Auto Undertaker

One of the world's greatest businesses

Table of Contents

• Introduction

• Company history

  • The early days

  • The shift to virtual bidding

• Business Overview

  • How a total loss is determined

  • How Copart processes totaled vehicles

  • Why use Copart?

  • Copart’s three types of arbitrage

  • International buyer base improves auction bid density

  • Who are Copart’s sellers?

  • Process for registering as a bidder

  • How the bidding process works

  • Revenue model

• Can you replicate Copart?

  • A digital and physical network

  • Deeper integration with insurers increases switching costs

  • Management team

• Financial performance

• Copart’s opportunities and risks

  • Opportunities to grow vehicle volumes

    • Structural increases in total loss frequency

    • International expansion

  • Risks to volumes

    • Autonomous vehicles

    • Competition from IAA

  • Average selling prices

    • Selling higher quality cars

  • Used car prices normalizing

• Valuation

Key Takeaways

• Copart is a two-sided marketplace that blends the aggregation of online buyers with the management of complex logistics on the supply side; their source of advantage straddles both the physical and digital spheres in a way that is next to impossible to replicate.

  • Copart isn’t just facilitating online auctions, it also transports and stores millions of vehicles per year on behalf of its customers; its online network is deeply integrated with the complex logistics of physically moving cars around the country and safely storing them. Without the physical network density of storage locations around the U.S., a sub-scale competitor’s transportation costs would be prohibitively high which makes it impossible for them to effectively compete with Copart.

  • Copart owns over 80% of its land which underpins a property moat that competitors simply cannot replicate due to the much stricter permitting regulations today than existed in the period during which Copart amassed its yard footprint.

• Copart has been an incredible wealth generation story: the company listed at $12 per share in 1994, generating a 35,900% return over the last 29 years when accounting for the seven separate stock splits in the interim period. That equates to the stock producing a 22% CAGR for almost three decades.

• Copart’s auctions maximize the proceeds insurers can achieve for totaled vehicles due to the company’s unrivaled buyer liquidity, which includes many offshore buyers. Notably 34% of U.S. units Copart sells are to non-U.S. buyers.

• Copart’s returns have been nothing short of incredible: the company has achieved a 31% return on cumulative incremental capital deployed into the business over the last eight years. Copart’s ROIC has averaged 28% over the last 10 years.

• Copart’s margins expanded significantly during the pandemic period. From FY15-FY19 (Copart has a July year-end), Copart’s agency-model all-in gross margin (i.e., including costs associated with yard operations) was 47.4%. It expanded to 56.2% in FY21 before moderating slightly to 52.5% in FY23. A significant contributor to that margin increase was used vehicle price inflation. Volume-driven growth converts to gross profit at roughly 65% incremental margins, while pricing-led growth converts at close to a 100% incremental margin.

• The total loss frequency has increased materially over the last few decades, going from 4% in 1980 to a high-teens percentage today. We estimate that the total loss frequency could hit a mid-20s% rate in the medium term, and over the long run it’s possible it could exceed 30% in a blue-sky scenario. There is a very long runway for total loss frequency to increase and we do not see the structural drivers of total loss rates abating. Vehicles are only becoming more complex to repair with more sensors and software, increasing amounts of more expensive lightweight materials are being used in new vehicles to comply with tightening emissions standards, there is continuing repair shop consolidation, and the supply of qualified automotive repair technicians is likely to continue to dwindle.

• Our analysis of the pull-through of changes in vehicle ASPs to Copart’s revenue per unit incorporates the split between fixed fees and variable fees. This fixed fee component means that a 1% increase in ASP does not translate into a 1% increase in Copart’s revenue per unit. Following a period of ASP-driven top-line growth, Copart now has a higher percentage of its RPU composed of variable fees, which are vulnerable to used price declines. With used car prices normalizing, the market is likely underestimating these dynamics as well as the different incrementality of volume-led growth for the bottom line, relative to the extremely high margin pricing-led growth that’s occurred in recent years.

• Copart trades at 31x forward earnings and 50x its FCF. Based on our estimates of FY28 FCF per share, the company is likely to only achieve a high-single digit IRR from today’s prices and fails to meet Bristlemoon’s return thresholds.

Introduction

If ever there was a poster child for the American Dream, Willis Johnson, the Founder of Copart, would rank highly. Starting with just one auto tiny scrap yard in California, Johnson over a span of decades built Copart into a $40 billion market capitalization company that dominates the online auto auction market. Copart is a two-sided marketplace that blends the aggregation of online buyers with the management of complex logistics on the supply side; their source of advantage straddles both the physical and digital spheres in a way that is next to impossible to replicate.

Source: LA Times (Willis Johnson and his car collection)

Copart occupies a unique position in the automotive value chain: their auction platform primarily helps totaled or otherwise end-of-life vehicles find a home. Johnson summed up the importance of Copart to the auto ecosystem when he was pitching the company to an investment banker, Barry Rosenstein (yes, the same Barry Rosenstein who founded the hedge fund JANA Partners), who he wanted to help list Copart on the Nasdaq exchange:

Think of us like the local sewer system…We’re a utility. Nothing can get rid of us – nothing. Two of the biggest businesses in the world are car manufacturers and insurance companies…If insurance companies don’t write insurance policies on cars, then they’re out of business. If manufacturers don’t make cars, then they’re out of business. They’re always gonna make cars, and they’re always gonna insure them. We’re the guy in between…As long as we’ve got the land in the right place to put the cars on, we can’t fail. We are like the septic tanks of the sewer system. You can’t have the system without us[1].

In this sense, you can think of Copart as having utility-like status for the recycling of vehicles, dutifully matching highly dispersed global buyer demand for totaled vehicles with the sellers of these assets, who are typically a more concentrated set of insurance companies.

The company went public in 1994 and is one of the great stock market wealth compounding stories. Copart listed at $12 per share, generating a 35,900% return over the last 29 years when accounting for the seven separate stock splits in the interim period. That equates to the stock producing a 22% CAGR for almost three decades.

Source: Koyfin (Bristlemoon readers can get 20% off a Koyfin subscription via this link)

Company History

The early days

Born in Clinton, Oklahoma in 1947, Willis Johnson came from humble beginnings. His father, Willis Johnson Sr., couldn’t read but had an enterprising spirit which led to him getting into the wrecking yard business, a decision that paved the way for Willis Johnson Jr.’s initial foray into auto dismantling. As Willis Johnson Jr. told it:  

This was my introduction to the world of auto dismantling and recycling, and I loved it. I found enjoyment in the destruction – smashing and cutting and taking things apart. I didn’t like putting cars together because it required too much precision. But it was easy to take cars apart. I also liked the idea that the cars were being reused in other ways. It was recycling in its earliest form.[2]

Johnson couldn’t shake off his love for the dismantling business, and in August of 1972, he found a small five-acre auto-dismantling yard in Rancho Cordova, California called Rand’s Auto Wreckers[3]. The next part of the story shows Johnson’s dogged determination in making things happen – a force of will that no doubt kept pushing his business forward. The owners of the wrecking yard were in their sixties and ready to retire. They wanted $75,000 for the business. That might not sound like much by today’s standards, but for context, Johnson had just bought a 1,600-square-foot, three-bedroom house for around $11,000. Put simply, he wanted the dismantling yard but didn’t have the money.

Johnson offered them $15,000 down with interest-only payments. They agreed. However, there was another problem: he didn’t have $15,000.

Johnson had $5,000 in savings, borrowed an additional $5,000, and ended up selling the recently purchased family home to fund the remaining $5,000 portion. He moved his wife and kids into a small trailer – one that measured twelve feet wide and thirty feet long – situated on the wrecking yard. The deal was closed, and Johnson changed the name to Mather Auto Dismantlers, with the inspiration for the name being drawn from nearby air force base (Johnson was a Vietnam War veteran who earned a Purple Heart for his service after he was wounded in a mortar attack).

Johnson’s start in the wrecking business is markedly different to Copart’s business today. A wrecking yard (also known as a dismantling yard) primarily deals in used auto parts and recycling scrap iron. These businesses buy mostly end-of-life vehicles that aren’t drivable, transport them to their lot, and pick apart the vehicle like a vulture scavenging a carcass. The car parts of value are siphoned off, the car is depolluted (fluids are drained from the car), and then the shell is hauled to a smelter where the wrecker gets paid a per ton rate for the iron, copper, and aluminum components.

Johnson was always looking for ways to optimize his business. His dismantling yard increased its profitability when Johnson was one of the first in the auto industry to not just dismantle cars, but to go a step further and dismantle the parts themselves. For example, rather than just pull out a 4.6 liter motor and sell that as a part, Johnson would take off and sell the carburetor, alternator, starter, etc. (some of these parts would dry out and cease to function correctly anyway if the motor sat for too long). While Johnson’s competitors sold the motor for $400, his unbundled approach would yield $700 for the same parts sold on an individual basis and there were fewer buy-backs from customers as Mather Auto Dismantlers didn’t need to guarantee all the parts on the motor[4].

Johnson also realized that in order to compete, Mather Auto Dismantlers needed to specialize in a car brand or model that the other dismantlers in town didn’t want to carry. Johnson decided to specialize in Chrysler, Dodge and Plymouth, cars that other dismantlers shunned because they weren’t hot-selling items. The results were phenomenal and demonstrate Johnson’s savviness as a businessman:

Before we specialized, Curtis [Willis Johnson’s business partner at the time] and I were running between $3,500 and $5,000 worth of parts a month at Mather. After specializing, we were running around $3,500 worth of parts a day.

It might have become apparent to those familiar with Copart, that this business backstory described thus far is unfamiliar, both in terms of the name and type of business. It wasn’t until 1982 that Willis Johnson and long-time friend Peter Kay branched out from auto dismantling by purchasing Bob’s Tow Services (BTS). BTS was a Vallejo, California-based insurance auto auction business that sold whole cars for the insurance industry. The way it works is that if you have an automotive accident, the insurance company pays out the claim and then takes the damaged vehicle to somewhere like BTS to recover some of the cost. Bob Kukuruza, the owner of BTS wanted $1 million for the business – an astronomical sum at the time. This was 10x the value of the trucks and tractors, and the land was excluded from the deal. The price was also 15x pre-tax earnings, a crazy sum for a small, private business. However, Johnson saw the potential to expand the business far beyond its current profitability.

When Johnson incorporated BTS for liability protection and to keep taxes separate, he decided to name the corporation Copart. The name came from a dismantling magazine that Johnson had started, and which was sitting idle. Rather than pay $600 to incorporate a name, Johnson decided to just move the C-Corp over and change the name of BTS to Copart[5].

The shift to virtual bidding

Where Copart really began to transform into the business it is today was during the late 1990s. Jay Adair (the current Copart Co-CEO, and son-in-law to Willis Johnson) noticed that buyers for Copart’s auctions were hiring representatives to travel to the yard to place bids. One rep called Brad was coming to a Copart yard and placing bids for twenty different buyers. Adair took issue with this, and wanted to devise a way to let buyers submit a bid online. This would mean that buyers would not be required to physically attend each auction. The concept of online bidding was novel and had not been applied to automotive salvage auctions up until that point. This pivot was a great success, with Copart generating more than $1 million in online sales the first quarter[6], and this rapidly accelerated to $10 million in sales per quarter[7].

The decision to shift to online bidding unlocked enormous buyer liquidity in ways that were previously unimaginable. Buyers were not only making cross-state bids for vehicles (in stark contrast to the previously localized nature of bidding before the introduction of online bidding), they were also making cross-country bids. A car in San Diego could end up in Connecticut. Copart leaned into this by photographing each vehicle and uploading the pictures to the Copart website (after six months every Copart vehicle had pictures), making it easier for buyers to discern the condition of the vehicle. As Co-CEO Jay Adair recalled: "You couldn't see pictures of cars when you bought a new car. We were the first to do it”[8].

Internet buyers wanted the ability to increase their bids on the day of the sale. At the time, building out this functionality was no easy task. Copart eventually introduced VB1 (it stood for Virtual Bidding First Generation) which was an online auction platform that worked in real time. Initially, virtual bidding was working in conjunction with the live auctions, which created complexity for staff to coordinate the virtual bids with the in-person auction. It was messy. This prompted Copart to build out VB2: the second generation of the company’s virtual bidding platform that operated entirely online, eliminating the need for holding physical auctions. The success of shifting to an online-only auction model even surprised Adair, who had conceived the idea for online bidding:

I remember being asked, ‘how big do you think Internet bidding can be?’ And I said, ‘I think it could be 10% of our volume.’ And by 2003, it was 100% of our volume.

By the end of 2003, VB2 was rolled out to the entire company (which at the time was comprised of 94 yards). In 2013, Copart launched VB3, which supports all the latest browsers and eliminated the need for plugins.

Source: Copart.com (Copart’s Sun Valley, California yard)

Business Overview

Copart (CPRT) can be thought of as the undertaker of the auto world. Every vehicle has a lifecycle that inevitably comes to an end: a car will either accumulate enough mileage such that the condition degrades to a point where it’s not worth repairing, or the vehicle will be involved in an accident whereby it’s deemed a total loss. Most of the vehicles Copart sells are on behalf of insurance companies and are typically vehicles involved in an accident or natural disaster. These are vehicles that are deemed to be a total loss (i.e., totaled or written off by the insurance company).

How a total loss is determined

When looking at Copart, it’s important to understand when a car will be fixed, and when a car will be deemed a total loss. The diagram below illustrates the series of events that follow an automotive accident, and where Copart steps in to process the vehicle.

Source: Company filings

Once a vehicle is involved in an accident – this could be due to a collision, or hail, flood, or fire damage from natural disasters – then if the vehicle is insured, an appraisal of the damage is conducted. The insurance company will make a decision to either fix or salvage the vehicle. The salvage equation is mathematical and involves three factors:

1. The pre-accident value (PAV) of the vehicle (also referred to as Actual Cash Value, or ACV);

2. The repair costs (RC); and

3. The salvage value

The salvage value refers to the amount of money an insurer would get if they sold the damaged vehicle through a licensed salvage vendor (such as Copart). The salvage value depends on the type of vehicle and the extent of its damage.

An insurer will decide to repair a vehicle where:

PAV – RC > Salvage Value

An insurer will decide to salvage a vehicle (i.e., declare it a total loss) where:

PAV – RC < Salvage Value

Let’s consider an example of a vehicle that before the accident had a $10,000 value. From this $10,000 pre-accident value, we must deduct the estimated repair costs and then compare the resulting figure against the salvage value for the vehicle. Let’s say that that the insurer could recoup $4,000 if they sold the damaged vehicle at one of Copart’s salvage auctions. If the repair costs are $7,000, then the vehicle would be deemed a total loss (i.e., $10,000 PAV - $7,000 RC = $3,000, which is less than $4,000 salvage value).

Also note that the cost of repair includes labor, the cost of parts, and the cost of supplying the insured driver with a rental vehicle while their vehicle is being fixed. Labor costs have been inflating in the U.S. due to few skilled automotive repair workers as well as broader inflation. On top of this, the increased electronic content of newer vehicles is requiring more hours for a vehicle to be repaired.

In practice, the threshold for determining a total loss varies by state in the U.S. Oftentimes a total loss is obvious when it costs more to repair a vehicle than it does to replace it – that is, the repair costs are greater than the actual cash value of the vehicle (in this scenario the salvage value is irrelevant to the total loss determination). Expressed in a formula, a car will be totaled when PAV – RC < 0.

In more borderline cases where PAV – RC > 0, it is worth noting that different states have different total loss thresholds. Oklahoma, for example, has the lowest total loss threshold of all the states of 60%, meaning that if the repair costs are greater than 60% of the vehicle’s actual cash value then the state requires the insurer to automatically declare the vehicle a total loss. In the example above, the $7,000 of repair costs equate to 70% of the actual cash value of the car, such that the state of Oklahoma, if that was the relevant jurisdiction, would require a total loss determination. Florida, Missouri, and Oregon, on the other hand, have higher total loss thresholds of 80%, meaning that the car in our example would not automatically be written off, but would instead be compared against the salvage value of the vehicle.

Total loss frequency has markedly increased in recent decades, and Jeffrey Liaw, Co-CEO of Copart made some comments around this on the 4Q22 earnings call: “The history of total loss frequency from 4% in 1980 or so to 20% as of a couple of years ago, has been the product of 2 key factors: vehicle complexity and composition, making cars more expensive to repair while our auction liquidity and global buyer base has made them more efficient to total instead.”

The total loss decision often involves a level of discretion of the insurer. Sometimes an insurer will make a total loss determination to keep a customer happy (and to keep that customer’s auto insurance business!) This also relates to why Copart, and the efficient processing of these totaled vehicles is so important: to the extent that an insurance company takes too long to process an automotive insurance claim, it could cause that customer to defect to a competitor.

Now that we understand the total loss determination equation, we can look at how Copart processes these totaled vehicles.

How Copart processes totaled vehicles

The diagram below traces the steps involved in processing an insured vehicle that has been involved in an accident. The entire process takes approximately 45-90 days; it depends on the DMV processing speeds of each state, which vary.

Source: Bristlemoon Capital; Company filings; IAA

For more detail on the steps involved in how Copart processes a vehicle, the following flow chart provides some additional color.

Source: Bristlemoon Capital; Company filings

A notable bottleneck is the requirement for each state Department of Motor Vehicles (DMV) to process the title of that vehicle. In the U.S. total loss vehicles can be sold in most states only after obtaining a salvage title from the DMV. A salvage title is an official indication that a vehicle is damaged and considered a total loss (attaching the salvage designation to a car’s title means that future buyers can do a title check to see that the vehicle was previously written off).

Copart, in conjunction with the American Property Casualty Insurance Association (APCIA), is pushing for electronic titling and the digital transmission of titles to help speed up the title transfer process. The process is archaic, and it is worth noting that the lack of nationwide vehicle registration process means that title transfer processes are determined on a state-by-state basis. This makes change more difficult to enact, given that 50 states need to be convinced to make changes to their systems. However, any progress on this front could speed up vehicle title transfers, which would ultimately improve the profitability and returns CPRT is able to generate from its assets.

By this stage we should have a good sense of why a vehicle gets totaled and the procedures in place to process that vehicle. But why do sellers choose Copart as the company to auction the vehicle?

Why use Copart?

Copart runs one of the world’s largest online auctions for vehicles. If you think about an insurance company that needs to dispose of a written off vehicle there is one thing they care about most: maximizing the proceeds from that vehicle sale. The way to do that is to sell the vehicle at an auction that has the largest number of potential buyers. That auction is what Copart offers.

Source: Bristlemoon Capital; Company filings; IAA