Copart: Junkyards and Profits

11/07/2016 7:00 am EST

Focus: STOCKS

Douglas Gerlach

President, ICLUBcentral, Inc.

Our latest recommendation is the country’s largest operator of junkyards and auto salvage auctions, explains Doug Gerlach, editor of the Investor Advisory Service newsletter.

Copart (CPRT) began on a dirt lot in California in 1982. It then bought up salvage yards all across the country, signed contracts with insurance companies, and shifted live auctions to the Internet, becoming the world’s largest online seller of automobiles.

The business is wonderfully simple. When a car is in an accident, the owner’s insurance carrier estimates repair costs. If the cost exceeds the car’s pre-accident value less its salvage value, the insurer sends the “totaled” car to Copart.

Copart auctions the clunker online to the highest bidder, with the proceeds going to the insurance company. Copart takes a sales commission from buyer and seller.

Insurance companies make up 80% of sellers, with the rest coming from banks, charities, car dealerships, and car rental agencies. The primary buyers are vehicle dismantlers who sell the parts to mechanics and body shops.

While industry volumes are growing at 8%, Copart has been taking share lately with multiple wins including a deal with Farmers Insurance. As a result, Copart’s volumes grew 12% in fiscal 2016 and 14% in fiscal Q4.

While Copart eschews Wall Street's short-term focus and doesn’t give forward guidance, it did say it expects more market share gains on top of about 8% market growth for the next several years. It also said the number of cars in its yards was up a robust 20% in fiscal Q4.

A key risk is that new accident avoidance and self-driving technologies could sharply reduce accident frequencies in the future.

At the same time, accident rates are actually increasing in recent years and the rising technology content of newer cars will likely result in higher repair costs.

The unknown future impact of Brexit also poses a risk to Copart, as it has successfully replicated its model in the UK, where it generates roughly 20% of its sales. Copart also has its sights on Germany and Western Europe, but it’s still early innings there.

We think Copart can leverage 10% sales growth into 15% EPS growth over the next five years. If we project this growth forward and apply a high P/E of 24.7 we get a potential high price of 110.

Applying a low P/E of 17.4 to 2016 EPS of $2.21 gives a possible low price of $39. This yields an upside/downside ratio of 3.5 to 1 and projected annual return of 15%.

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By Doug Gerlach, Editor of the Investor Advisory Service newsletter

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