Spun out from KAR Auction Services (KAR) in mid-2019, IAA (IAA) is a digital auction marketplace connecting buyers and sellers of damaged, total loss, and low-value vehicles, notes Doug Gerlach, editor of Investor Advisory Service.
About 95% of vehicles sold on IAA’s platform are done on a consignment basis, meaning sellers continue to own the vehicles until they are sold to buyers. The company has more than 200 locations across the U.S., Canada, and the U.K. where it stores vehicles it processes for sellers.
Combined, IAA and fellow IAS company Copart account for the bulk of the salvage vehicle market in North America. Approximately 80% of the company’s volume is sourced from insurance providers, where there has been an accident resulting in a salvage vehicle the provider needs to sell. IAA benefits from long-term partnerships with most of the major U.S. insurers.
In April 2020 the company shifted to a fully online, digital auction model, which reduced the costs associated with running live physical auctions and grew the percentage of transactions subject to an internet fee.
Volumes in the salvage market are expected to grow 5%-7% annually over the long term. The other 20% of volume comes from non-insurance providers, such as dealerships, rental car companies, and charitable organizations. There is opportunity to meaningfully grow this business in coming years.
The company’s buyer base is global and diverse. Buyers include vehicle dismantlers, rebuilders, dealers, and exporters. Fees are earned from both buyers and sellers on each transaction, though buyers account for approximately two-thirds of the company’s revenue.
While the pandemic initially resulted in fewer vehicles on the road and a meaningful decline in miles driven, conditions have rebounded more quickly than anticipated, nearly returning to pre-pandemic levels.
The company also continues to benefit from an increase in total loss frequency, which is the percentage of cars involved in accidents that insurance companies choose to run through a salvage auction rather than repair.
This decision is driven by the relationship between repair costs, used car values, and auction returns. Total loss rates have increased over the past several years and this trend is expected to continue for several reasons.
First, repair costs have risen due to greater vehicle complexity and higher labor and parts costs. Secondly, the average age of cars on the road has continued to increase.
Third, IAA has been able to fetch better prices at auction given its efforts to enhance its buyer base, partly through the addition of more international buyers. A greater number of buyers leads to better prices for sellers at auction.
We anticipate 12% normalized long-term EPS growth. However, using pandemic-impacted 2020 results as a base, we project EPS growth of 17% over the next five years. This results in 2025 EPS of $3.16. Applying a high P/E of 30 results in a potential high price of $95.
Applying a low P/E of 20 to trailing EPS of $2.01 yields a low price of $40. Therefore, we model an upside-to-downside ratio of 3.2 to 1 and a projected high total return of more than 12% annually.
