Investor Dialogue: Copart

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Disclaimer: This interview is for informational purposes only and should not be relied upon as a basis for investment decisions. In Practise is an independent publisher and all opinions expressed by guests are solely their own opinions and do not reflect the opinion of In Practise.

How do you look at long run total loss frequency?

Analyst 1: I think the short-term reaction is partly because of everything that is going on in the market but also the price of oil and the fear that it will impact miles driven. That’s what happened last time oil spiked; miles driven came down. That’s the million-dollar question, right off the bat. Everybody I talk to about Copart or IAA, I always ask them this question about the long-term effect of electric vehicles, driver assist and autonomous vehicles. I think it’s helpful to remember that there are a few different main KPIs that you want to focus on. Miles driven is one of them. The other one is the accident rate, which you mentioned. The last piece is the salvage rate. There are really three different pieces.

It’s complicated to get a handle on it because, when you move one thing, another one shifts in another direction. For example, you could say that increased technology will lower the accident rate but, on the other hand, are those cars going to be easier to total because they are so much more expensive? I’ve talked to people and you can now total a car in a 15 mph accident, especially if the airbags go off and all the sensors that are in the bumper become extremely expensive to fix. Suddenly, you’ve totaled that car in a very minor accident. That is the countervailing factor. You could have accidents coming down but you are going to end up totaling a lot more of these cars when they do get in an accident.

The other part of it is, what is the threshold? It still seems as if we are a long way from autonomous vehicles but if there are 3% or 5% on the road, does that matter? What is the tipping point? Is it 20%? 30%? I don’t know. Then there are other countervailing factors too. The accident rate had been falling for years and then, recently, spiked up. Part of it was distracted drivers; people are on their phones. There are all sorts of weird things that can happen.

Partly I think about this in the fact that there are always different variables you go through. So far, I don’t think that the electric vehicle or autonomous vehicle appearing on the horizon is enough to get me concerned. But I would be interested to hear if anybody else has other opinions about it.

Analyst 2: I think this threat was around six years ago, with people overreacting to autonomous driving then. I think our thought process is, it’s going to be challenging because it is something that has to be 100% ready. You can’t be 98% ready. It takes a long time to get that last 2%, 3%, 4% to market. Once it’s available, it’s going to take a long time to see penetration really rise. For Copart, I think they are continuing to benefit. Loss frequency continues to go up to about 20% today. That doesn’t mean it still can’t go to 25% or 30%. It was mid to low double digits 10 years ago. I think that is one of the biggest surprises on our end; loss frequency has gone from 13%, 14% to 19%, in a decade.

It is the cost of repairs. The more technology that is embedded in the vehicle, the more expensive it is to repair. Distraction is prevalent, as well, with cellphones and other items. You look at Copart’s trajectory and the seeds are planting internationally. That is even longer tailwinds for those emerging markets where penetration is nearly as viable as it is in the US. You will continue to businesses thinking they can gain share and convert those markets to something similar to the US market. I think Copart will be in a good spot, for many years.

Analyst 3: If you look at total loss frequency of cars that are 2014 or newer, which is when they changed over to the aluminum base and more sensors and technology, those total loss frequencies and total loss vehicles are now at 25%. You are starting to see a rapid jump, with eight-year-old cars or older, just because of changes that have occurred in the vehicles. As was just said, there is no reason why you couldn’t see it go from 25% to 35% of total loss.

Analyst 4: Just thinking about the environment that we are in, with costs going up in general – wages and materials – that just helps the business here. The value of the vehicles and what it is going to take to replace or fix them increases the potential for them to be totaled anyway, even if you exclude the technology aspect of it and just look at the raw material and labor aspect.

Isn’t the accident rate one thing that could change or that governments or OEMs are really looking to try and, at least, reduce. We don’t need full AVs to eliminate accidents, for it to have an impact on the units that have been salvaged. If you have increased penetration of ADAS, or better ADAS, the delta could be quite large on the accident rate, effectively. If there is any risk in that total loss frequency, is it from accidents or is there something else that would maybe worry you, that you would be looking at, as a KPI?

Analyst 2: Technology has got significantly better in the last 10 years, but we haven’t really seen loss frequency or accident rate really change. Cars are much more safe, with the sensors, the autobraking and lane assist. All those items are helping, but you still have people on the road, being irrational, and accidents happen. I don’t really see how it’s possible to have a massive impact on accident rate, until you get to 100% fully automated.

Analyst 1: The irony is, in the thick of the whole Covid pandemic, when miles driven had fallen for a little while, the accident rate went up quite a bit. It was speeding and distracted drivers. Suddenly, they could go a lot faster. It’s weird to think about one variable and just change that, because it never happens in isolation; there are always other things. Accident rate would be one and the other thing would be if miles driven somehow went the other way. That’s also hard to see because you have a rising population, but you do have more people staying at home. That is also an important part that drives the others.

Analyst 2: As you said, there are so many different idiosyncratic factors that impact us. People weren’t travelling internationally during Covid, so they vacationed in the States. Then you’ve got other dynamics, such as the car parc aging which means more cars totaled because their average age is 12 years. There are all these different little factors where it is hard to pinpoint one thing that would dictate a trend.

When you add them all together and you look at Copart’s competitive advantage and the market share gained, they profit because of the service they provide and the returns on investment that their clients get. You can see why they are so successful and that’s why I think the multiple has expanded. The market is appreciating the sustainability of the business and you get founders and leaders that are fully invested and are driving a unique culture, at Copart, which is a little harder to define, quantitatively.

Analyst 1: It seems as if that competitive advantage just gets stronger over time because it’s more and more difficult to replace what Copart has built. You’re not going to find places where you can put 30,000 cars, close to a big city.

Analyst 4: It’s like layers of competitive advantage. You have the physical, geographic competitive advantage and then you have the network effects with the distribution side and the auction business with the customers. There are all these aspects to it where it’s competitive advantage layered on competitive advantage, which is very hard to attack. It’s easy to attack one competitive advantage; it’s very hard to attack layers of them, simultaneously.

Just on the point of the network and the buyer demand, is there any regulatory risk of 31%, 34% of US vehicles being sold internationally? From my understanding, a lot of these are rebuilders or people in foreign countries buying busted US vehicles that may not meet safety regulations and are going to drive them in Europe, or elsewhere. Is there any regulatory risk of arbitraging safety rules in different countries, that could potentially unwind that network effect?

Analyst 2: I’ve not seen anything. I don’t think Mexico is going to come down hard on safety standards on vehicles on the road. I don’t think it’s a huge priority for them. The biggest market, outside the US, is Mexico, with 7% of sales. Then you go to the Middle East, Eastern Europe and other parts of the market and I don’t think it will be a big priority from a safety perspective.

If these cars are much more complex, with more electronics, can you actually repair them? Or are people in the Middle East just driving around with no sensors, that might not meet US regulations? Is there a risk in the fact that you just can’t rebuild these more complex vehicles, at some point?

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