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As explained in my recent 3M (MMM) Is A Toxic Dividend King To Avoid guest post at Dividend Power, many investors gravitate to investments that offer attractive dividend metrics. Because of this, these same investors will automatically ignore Copart (CPRT) because it does not distribute a dividend.
Unlike MMM, however, CPRT is rapidly growing (~$0.924B Revenue in FY2012 versus ~$3.501B in FY2022). We would typically expect a rapidly growing company to exhibit some financial stress. CPRT, however, faces no such problem. As of July 31, 2022 (FYE2022) it had enough cash, cash equivalents, and restricted cash on its Balance Sheet to have ~$0.701B remaining if it elected to repay 100% of its Liabilities. Essentially, Copart is the epitome of a safe investment.
I last wrote about CPRT in this May 19, 2022 post at which time it had just released its Q3 and YTD2022 results.
I now revisit CPRT following the release of Q4 and FY2022 results after the September 7, 2022 market close.
Industry and Business Overview
Investors unfamiliar with CPRT are encouraged to look at the company's website and review Part 1 of the FY2021 Form 10-K.
This Forbes article, although published in November 2020, also provides a good introduction to the company.
The business operates in a manner that ensures enterprise sustainability; the strategic approach is to own the vast majority of its real estate and storage capacity.
On the Q4 earnings call, management stated that over the last 5 years alone, CPRT has invested ~$2B in land acquisition and development.
CPRT operates on nearly 16,000 acres of land worldwide and owns ~90% of it. The company has 200+ locations.
Given that the company was founded in 1982, the land value of some of its locations has undoubtedly appreciated over the years. As a result, the 'land' portion of the fixed assets reflected on the Balance Sheet is likely understated. However, investors should be aware that the operation of its storage facilities poses certain environmental risks, which could adversely affect consolidated results of operations, financial position, or cash flows. This risk is addressed on page 24 of 99 in the FY2021 Form 10-K.
CPRT's market cap is currently ~$27.6B. Its financial picture is almost the polar opposite of its largest US competitors (Manheim, Inc. which bills itself as the world's largest wholesale auto auction is the exception. It is a subsidiary of Cox Automotive, which in turn is a subsidiary of privately owned Cox Enterprises, Inc.).
The publicly listed companies in the 'Competition' segment of CPRT's FY2021 Form 10-K are as follows:
- LKQ Corporation (LKQ) has a $14.721B market cap. Moody's initiated coverage in May 2022 and assigns a Baa3 long-term issuer rating. S&P Global completed its annual review of LKQ in May 2022 and assigns a BBB- local currency issuer credit rating. Both ratings are one tier above non-investment grade.
- IAA, Inc. (IAA) has a $4.815B market cap. Moody's assigns a B2 rating to its domestic senior unsecured debt and S&P Global assigns BB- rating. Both ratings are non-investment grade.
- KAR Auction Services, Inc. (KAR) has a $1.582B market cap. Moody's assigns a B2 domestic senior unsecured debt rating while S&P Global assigns a B rating. Both ratings are non-investment grade.
- Carvana Co. (CVNA) has a $6.504B market cap. In May 2022, it acquired ADESA’s U.S. physical auction business from KAR. Moody's assigns a Caa2 rating to CVNA's domestic senior unsecured debt while S&P Global assigns a CCC+ rating. These are extremely speculative ratings. To make matters worse, one of the major shareholders is an ex-con.
The credit risk of these 4 companies is such that I automatically disregard them as potential investments.
Financials
Q4 and FY2022 Results
CPRT's FY2022 Form 10-K is not yet available. Its Form 8-K, however, can be accessed here.
In FY2022, global gross profit increased by $263.1 million or 19.6% and the gross margin percentage decreased by ~400 basis points to 45.9%. U.S. margins decreased from 52.6% to 48.9% and international margins decreased from 35.1% to 29.9%.
This margin decline was primarily attributable to 2 factors:
- 200 - 225 basis points of the fiscal year decline is due to the contraction in gross margin rate on purchased vehicles as the absolute values of those vehicles increase.
- cost inflation in both towing and labour.
Management, however, believes CPRT can continue to increase margin and returns on capital over time as it benefits from scale and finds further operational efficiencies through technology and innovation.
While FY2022 General and Administrative (G&A) expenses increased by 18.2% relative to FY2021, ~$6.6 million of the increase is attributable to certain discrete legal items. G&A can be volatile from period to period. Over the longer term, however, these expenses are anticipated to decline as a percentage of revenue as CPRT grows and creates additional leverage.
Liquidity
As of July 31, 2022, CPRT had $2.6B of liquidity. This was comprised of ~$1.4B in cash and cash equivalents and a $1.2B undrawn revolving credit facility.
In Q4, CPRT retired the $0.4B of private placement notes that were due in $0.1B tranches between 2022 and 2029. It incurred a $16.8 million prepayment penalty which was nearly equivalent to 1 year of interest payments if the notes had not been retired. Management deemed this to be the superior choice given cash on hand, projected interest savings, and the relative inflexibility of the private placement notes.
We see this prepayment on the FYE2022 Consolidated Statements of Cash Flows and Consolidated Balance Sheets.
Credit Ratings
There is no debt to rate so CPRT is not covered by any rating agency.
Dividend and Dividend Yield
CPRT does not distribute a dividend.
In FY2012 - FY2021, CPRT's weighted average number of outstanding shares (in millions of shares) was 263, 260, 262, 263, 244, 237, 242, 240, 239, and 240. The diluted weighted average common shares outstanding in Q4 2022 was ~240.7.
CPRT generates ample Free Cash Flow (in millions of $) (175, 69, 181, 186, 159, 320, 247, 273, 326, 528, and 839 in FY2012 - FY2022) to repurchase a significant number of its shares. It has not done so in recent years since management considers the retention of funds for growth purposes to be the best means by which to maximize shareholder value.
Valuation
My February 17, 2022 post touched upon CPRT's historical valuations. At the time of that post, the two online trading platforms I use had yet to be updated to reflect the brokers' earnings estimates based on Q2 and YTD2022 results. I envisioned the brokers would increase their estimates. However, using the existing forward adjusted diluted EPS estimates and the ~$125.70 share price, the forward adjusted diluted PE levels were:
- FY2022 - 10 brokers - mean of $4.31 and low/high of $4.02 - $4.56. Using the current ~$125.70 share price and the mean estimate, the forward adjusted diluted PE is ~29.2.
- FY2023 - 10 brokers - mean of $4.62 and low/high of $4.23 - $5.00. Using the current ~$125.70 share price and the mean estimate, the forward adjusted diluted PE is ~27.2.
When I analyzed CPRT in May using Q3 and YTD2022 results, the forward adjusted diluted PE levels based on the current ~$111 share price and forward adjusted diluted EPS estimates were:
- FY2022 - 9 brokers - mean of $4.44 and low/high of $4.25 - $4.87. Using the current share price and the mean estimate, the forward adjusted diluted PE is ~25.
- FY2023 - 9 brokers - mean of $4.72 and low/high of $4.55 - $5.00. Using the current share price and the mean estimate, the forward adjusted diluted PE is ~23.5.
I acquired additional shares @ $113.725 on September 8, 2022 after CPRT had just reported $4.52 and $4.46 in FY2022 diluted EPS and adjusted diluted EPS. Using these metrics, CPRT's diluted PE and adjusted diluted PE are ~25 and ~25.5.
Using my $113.725 purchase price and the current forward adjusted diluted EPS estimates from the brokers (as of September 9) which cover CPRT, we get the following:
- FY2023 - 9 brokers - mean of $4.67 and low/high of $4.37 - $4.95. Using the mean estimate, the forward adjusted diluted PE is ~24.4.
- FY2024 - 8 brokers - mean of $5.11 and low/high of $4.70 - $5.42. Using the mean estimate, the forward adjusted diluted PE is ~22.3.
On September 10th, we have revisions to the broker estimates thereby resulting in a slightly more favourable forward valuation.
- FY2023 - 9 brokers - mean of $4.75 and low/high of $4.55 - $5.05. Using the mean estimate, the forward adjusted diluted PE is ~24.
- FY2024 - 3 brokers - mean of $5.17 and low/high of $5.00 - $5.27. Using the mean estimate, the forward adjusted diluted PE is ~22.
If we use the current $116.11 share price, the forward valuation is:
- FY2023 - 9 brokers - mean of $4.75 and low/high of $4.55 - $5.05. Using the mean estimate, the forward adjusted diluted PE is ~24.4.
- FY2024 - 3 brokers - mean of $5.17 and low/high of $5.00 - $5.27. Using the mean estimate, the forward adjusted diluted PE is ~22.5.
Despite the change in broker estimates and the slight increase in share price following my purchase, CPRT's valuation remains reasonable considering it is the epitome of a safe investment.
Final Thoughts
On the Q4 earnings call, management stated that it expects market conditions to revert to the historical norm of steadily rising total loss frequency. Furthermore, several other variables such as accident severity, repair duration, repair, labour costs, rental car cost, and part costs should contribute to this expected reversion and long-term trend.
The history of total loss frequency from 4% in the 1980s to 20% as of a couple of years ago, is the product of:
- vehicle complexity and composition which serve to make cars more expensive to repair; and
- CPRT's auction liquidity and global buyer base that make it more efficient to 'total' vehicles instead.
CPRT is the epitome of a safe investment. It is consistently profitable and it generates very strong Free Cash Flow. Furthermore, it could erase 100% of its Total Liabilities and still have ~$0.701B of cash and cash equivalents remaining.
With the heightened risk of an economic downturn in 2023, now is a good time to dial back risk. Based on my analysis, CPRT fits the bill. I have, therefore, increased my CPRT exposure within a 'Core' account in the FFJ Portfolio with the purchase of another 100 shares @ $113.725 on September 8, 2022.
I wish you much success on your journey to financial freedom!
Note: Please send any feedback, corrections, or questions to [email protected].
Disclosure: I am long CPRT.
Disclaimer: I do not know your circumstances and do not provide individualized advice or recommendations. I encourage you to make investment decisions by conducting your research and due diligence. Consult your financial advisor about your specific situation.
I wrote this article myself and it expresses my own opinions. I do not receive compensation for it and have no business relationship with any company mentioned in this article.
