Contents
The Canadian Federal government's 2024 Budget proposes to:
- increase the capital gains inclusion rate for capital gains realized on and after June 25, 2024, from 50% to 66.67% for corporations and trusts; and
- from 50% to 66.67% on the portion of capital gains realized in the year that exceed $250,000 for individuals.
This change in tax legislation has prompted me review all my holdings. In doing so, I have exited my exposure to inferior companies. This has generated additional liquidity which can be deployed toward increasing my exposure in great companies such as Copart (CPRT), a wonderful wide-moat company.
Recent posts about some of the companies I have exited are accessible through the Archives section of this site.
In my April 30 post I touched upon CPRT's Q2 and YTD2024 results and disclosed the following purchases:
- more CPRT shares for a young investor; and
- 400 shares @ ~$54.60 in one of the 'Core' accounts in the FFJ Portfolio thus bringing my exposure to 2800 shares.
Following the release of Q3 and YTD2024 results after the May 16 market close, I have acquired an additional 540 shares @ ~$53.93 in a 'Side' account within the FFJ Portfolio on May 17. With this purchase, I now have 3340 shares. The young investors I am helping on their journey to financial freedom also have CPRT exposure; I do not disclose details of their holdings.
Business Overview
CPRT is the largest online salvage vehicle auction operator in the US. It connects buyers and sellers around the world through its online auction platform.
A brief overview of CPRT is covered in my November 17, 2023 post. In addition, I strongly encourage you to learn about the company from its website and Part 1 of the FY2023 Form 10-K.
Investors will find CPRT's earnings per share (EPS) to be low relative to its share price which expalins the typically high PE (price earnings multiple). It is, however, important to realize that CPRT reports a high degree of depreciation for continued yard and technology investments which leads to moderate margin expansion.
CPRT is also in growth mode having increased its revenue ~5 fold since 2009. Within the past decade alone, CPRT has increased revenue from $1.163B in FY2014 to ~$3.168B in the first 3 quarters of FY2024! This is impressive for a business that isn't 'sexy'.
The company receives the majority of its vehicle volume through contracts with large auto insurers and sells them on consignment for high margins. In order to maintain strong relationships with insurance companies it must offer strong customer service. This means it must have ample land capacity in strategic geographic locations and adequate staffing levels to handle an influx of salvage vehicle volume on short notice after a disaster. For example, insurance companies needed to dispose of over 90,000 vehicles that were damaged from Hurricane Harvey in 2017.
Currently, CPRT has ~19,000 acres (~29.7 square miles or ~76.9 square kilometres) of outdoor vehicle storage of which 90% is owned and 10% is leased and a robust fleet of transportation assets. This acreage is more than double what it had in 2015.
NOTE: CPRT owns most of its land meaning it is not at the mercy of having to renegotiate leases prior to expiry. Imagine if CPRT did not own its land, was unable to renegotiate a particular lease, and had to relocate thousands of damaged vehicles to new properties!
CPRT's impressive service has led to market share gains over the last several years; a major US auto insurer shifted portions of its salvage vehicle volume to CPRT from competitor IAA (now owned by RB Global) following the Hurricane Harvey.
The strategy of owning large swaths of land does negatively impact short term performance. This is where CPRT's strong balance sheet comes into play!
Typically, CPRT incurs a loss when serving an area affected by a severe natural disaster as labor and vehicle hauling costs exceed revenue from additional vehicle volume. The strategy, however, works because CPRT can offer superior customer service that helps it foster stronger insurance relationships and future volume growth.
While average selling prices (ASP) have recently fallen by ~3% (less than 2% in the US and ~5% internationally), this comes as no surprise. ASPs of used vehicles should continue to decline from very high levels caused by the chip shortage. CPRT's ASP decline, however, has been far less than the 14% decline in the Manheim Used Vehicle Value Index. This reflects the strength of CPRT's digital that draws buyers and sellers throughout the world; CPRT's online-only global marketplace auction platform is the conduit for the movement of scrapped vehicles from the US to emerging markets; most buyers at CPRT's US auctions are from international locations and ~90% of vehicles sold at US auctions have bidding from foreign buyers.
Financials
Q3 and YTD2024 Results
CPRT's Q3 results are available through the SEC Filings section of the company's website.
Global revenue increased to ~$1.13B, representing growth of over $0.105B or ~10% relative to Q3 2023. Global service revenue increased ~$0.1B or ~11.7% for Q3, primarily due to increased volume. US service revenue grew by +10% and international service revenue grew by ~22% for the quarter.
General and administrative expenses, excluding stock-based compensation and depreciation, in Q3 was $76 million, reflecting an increase of more than $23 million from Q3 2023. The YoY increase reflects CPRT's investments in its sales, marketing, product and technology functions, and the financial consolidation of Purple Wave into CPRT's overall results; on October 10, 2023, CPRT announced that it is transforming the auction world with the acquisition of a majority interest in Purple Wave, an online heavy equipment auction company.
In addition, CPRT increased its investment in 2 key system implementations relating to its Finance and HR functions. Management expects these investments will result in more scalable processes and systems and provide the company with a greater operating leverage over the long term.
During the quarter, CPRT benefited from over $18 million of incremental interest income. The company invests excess cash into low risk treasury securities.
CPRT also benefited from a lower effective tax rate of 19.1%.
In Q3, GAAP operating income increased by over 4% to $0.437B, and Q3 GAAP net income increased by over 9% to $0.382B or $0.39/diluted common share.
New and used vehicle prices have very recently decreased steeply, while repair costs remain elevated. This is driving a strong and continued recovery in total loss frequency.
During Q3, CPRT observed a 14% YoY decline in the Manheim used vehicle value index. Although the ISS Fast Track reported a ~1.3% softening in accident severity for Q4 2023, accident severity is still up almost 9% when compared to the same quarter two years prior.
The combination of decreasing used vehicle values and elevated repair costs due to vehicle complexity and labor challenges in the repair industry has driven a recovery in total loss frequency back to pre-pandemic levels.
CPRT's management is of the opinion long-run trends continue to make repairing vehicles less economically attractive to insurance carriers. Totaling vehicles is more economically attractive to them and thus the total loss frequency is likely to continue to steadily grow.
As noted in prior posts, global weather conditions (ie. an increase in catastrophic events) are favorable for CPRT's business. CPRT's investments into its catastrophic team and infrastructure have allowed it to respond efficiently to customers' needs and it has responded to multiple smaller weather events so far this year. These smaller weather events have not, however, in the aggregate approached the magnitude of major catastrophic events like hurricanes Ian, Ida, and Harvey. Nonetheless, these comparatively smaller storms affected communities across the United States, including floods in the Houston area and tornado outbreaks in the Central Plains.
NOTE: Major research groups are predicting a serious storm season ahead with potentially as many as 31 named storms in 2024. This represents a 50% YoY increase!
CPRT continues to remain focused on proactive preparedness. It has invested heavily in on the ground teams, logistics technology, a fleet of vehicles and dedicated acreage reserved for handling the peak capacity needs that arise with major catastrophic events.
CPRT's non-insurance business (Blue Car) serves bank and finance fleet and rental segment partners. In Q3, CPRT reported ~23% - ~24% YoY growth.
A combination of the Copart Dealer Services business unit and NPA, the powersports auction platform, increased unit volumes sold by ~18%.
All told, the US non-insurance automotive and dealer volume, excluding low value and wholesale units increased 19% YoY.
On the international front, CPRT is leveraging its catastrophic response capabilities to support our clients in Southern Brazil and in the Persian Gulf.
Capital Allocation Strategy
CPRT's capital allocation strategy continues to prioritize the deployment of capital to grow the business. This consists of investing in:
- employees;
- operational capabilities including logistics;
- technology;
- real estate; and
- customer experience.
Operating Cash Flow (OCF) and Free Cash Flow (FCF)
Depreciation often serves as an indicator of how much needs to be invested to maintain assets in good operating condition.
In FY2014 - FY2023 and the first 9 months of FY2024, CPRT generated:
- OCF of (in billions of $): 0.263, 0.265, 0.332, 0.492, 0.535, 0.647, 0.918, 0.991, 1.177, 1.364, and 1.033.
- FCF of (in billions of $): 0.181, 0.186, 0.159, 0.320, 0.247, 0.273 0.326, 0.528, 0.839, 0.848, and 0.660.
Annual CAPEX was (in billions of $) 0.082, 0.079, 0.174, 0.172, 0.288, 0.374, 0.592, 0.463, 0.337, 0.517, and 0.373 during the same period. YTD depreciation and amortization is $0.139B.
In Q3, CPRT generated operating cash flow of ~$0.496B and ~$0.408B of free cash flow and CAPEX was ~$88 million. The majority of this CAPEX was CPRT's investments attributable to expanding its real estate and physical infrastructure to enhance capacity while simultaneously reducing our transportation costs and corresponding fuel consumption. An extensive list of CPRT's locations is accessible here.
Over the past 12 months, CPRT has deployed over $0.540B into its real estate portfolio and technology.
CPRT is a cash cow that does not distribute a dividend and share repurchases are almost non existent. By retaining so much free cash flow to grow the company, it has been able to support the growth in annual revenue from $1.163B in FY2014 to $3.168B in the first 9 months of FY2024 without having to rely on debt!
Return On Invested Capital (ROIC)
In FY2014 - FY2023, CPRT's ROIC (%) was 14.99, 15.86, 18.87, 26.34, 23.28, 29.15, 27.62, 27.03, 25.11, and 22.81.
High quality companies often generate a high ROIC. If a company generates a high ROIC, it needs to invest less to achieve a certain growth rate thus reducing the need for external capital.
A company that generates $0.15/profit for every $1 invested, for example, achieves a ROIC of 15%. I consider a ~15%+ ROIC to be a reasonable minimum threshold because most of the time, a company's cost of capital will be lower than this level. In the past 7 fiscal years, CPRT's ROIC has exceeded 20%!
When a company consistently generates a high ROIC over the long term and it is growing its revenue, it can reinvest a portion of its profits under favorable conditions thereby leading to a compounding effect. I would much rather invest in a growing company that can reinvest to create greater shareholder value than to invest in a company that has limited growth opportunities and thus chooses to distribute a growing dividend.
Risk Assessment
CPRT has no debt to rate.
At the end of Q3, CPRT had ~$4.3B of liquidity comprised of ~$3.1B in cash and investments and a ~$1.25B revolving credit facility.
Dividend and Dividend Yield
CPRT does not distribute a dividend and I sincerely hope it does not implement a dividend any time soon!
In FY2013 - FY2023, CPRT's weighted average number of outstanding shares (in millions of shares) was 1,038, 1,050, 1,051, 977, 948, 968, 962, 955, 961, 965, 967. The diluted weighted average common shares outstanding in Q3 2024 was ~976.5.
CPRT generates ample FCF to repurchase a significant number of its shares. It has not done so in recent years, however, since management deems the retention of funds for growth purposes to be the best means by which to maximize shareholder value.
Valuation
I reference my September 16, 2023 post in which I touched upon CPRT's valuation at the time of prior reviews.
On September 15, I purchased additional shares at ~$43.80. The following were the forward-adjusted diluted PE levels using the forward-adjusted diluted EPS broker estimates:
- FY2024 - 11 brokers - ~31.1 based on the mean of $1.41 and low/high of $1.35 - $1.54.
- FY2025 - 6 brokers - ~28.1 based on the mean of $1.56 and low/high of $1.40 - $1.75.
When I wrote my November 17, 2023 post, CPRT shares were trading at $50.50. Using this share price and the current broker estimates at the time, the forward-adjusted diluted PE levels were:
- FY2024 - 10 brokers - ~35 based on the mean of $1.44 and low/high of $1.35 - $1.54.
- FY2025 - 10 brokers - ~31 based on the mean of $1.62 and low/high of $1.40 - $1.75.
On April 30, I acquired additional shares at ~$54.60. Using this share price and the current broker estimates, the forward-adjusted diluted PE levels are:
- FY2024 - 11 brokers - ~38 based on the mean of $1.44 and low/high of $1.40 - $1.49.
- FY2025 - 11 brokers - ~33.7 based on the mean of $1.62 and low/high of $1.50 - $1.68.
- FY2026 - 4 brokers - ~30.5 based on the mean of $1.79 and low/high of $1.59 - $1.89.
On May 17, I acquired additional shares at ~$53.93. Using this share price and the current broker estimates, the forward-adjusted diluted PE levels are:
- FY2024 - 11 brokers - ~37.2 based on the mean of $1.45 and low/high of $1.43 - $1.49.
- FY2025 - 11 brokers - ~33.1 based on the mean of $1.63 and low/high of $1.55 - $1.68.
- FY2026 - 5 brokers - ~30 based on the mean of $1.79 and low/high of $1.65 - $1.89.
Although its valuation may dissuade some investors from investing in the company, CPRT deserves a premium valuation. It:
- is an industry leader;
- the value of the 19,000 acres it owns that is reflected on the financial statements understates the current value (CPRT started acquiring land decades ago);
- senior management has 'skin in the game' - their interests are closely aligned with long-term investors;
- does not rely on debt to fuel its growth;
- has ~$4.3B of liquidity; and
- consistently generates strong OCF and FCF.
Final Thoughts
It is far better to buy a wonderful company at a fair price than a fair company at a wonderful price. - Warren Buffett
Long-term strategic thinking has led the company to continually expand its capacity in areas at high risk of suffering from natural disasters. This has enabled it to set itself apart from the competition.
In addition, it has integrated itself into the salvage vehicle resale process by emphasizing its ancillary service offerings such as vehicle title transfer and salvage estimation services.
A link to the locations section on the company's website is provided earlier in this post. The yards located in non-catastrophic areas typically operate at ~85% capacity while the lots in catastrophic areas operate at ~70% capacity. This means that 20% - 25% of CPRT's owned acreage is most likely sitting idle at any given time. This allows it to quickly absorb capacity after a major disaster.
I suspect you can appreciate that the barriers to entry in this industry are enormous. Purchasing land (or rights to operate on land) creates an initial capital expenditures hurdle. Keep in mind that it is not always easy to find suitable land allowed to be zoned as vehicle storage yards ('not in my backyard - NIMBY'). Furthermore, generating no revenue because you must maintain vacant land in order to accommodate the insurance companies' immediate needs in the event of catastrophes is a huge fixed cost that is difficult to overcome.
Following a review of all my holdings, I am making a concerted effort to cull those I think have a low probability of generating attractive average annual total investment returns over the very long term. Of late, I have exited:
- SmartCentres Real Estate Investment Trust
- Enbridge
- BCE
- Emera
- The Bank of Montreal
- The Bank of Nova Scotia
- The Canadian Imperial Bank of Commerce
In addition, I have substantially reduced my exposure in The Toronto-Dominion Bank.
CPRT, however, is at the other end of the spectrum thus leading me to increase my exposure. Prior to February 17, 2022, I had no CPRT exposure. When I completed my 2023 Year End FFJ Portfolio Review, however, it was my 23rd largest holding. When I complete my next portfolio review, I expect CPRT will be a top 20 holding.
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.
