Copart, Inc. (CPRT) Earnings Call Transcript & Summary

Welcome to the Copart corporate presentation. I'm Craig Kennison with Baird Research. Copart operates purely online auctions for used wholesale and repairable vehicles for well over 3 million cars, probably 4 million cars. It has very wide moats based on vast property ownership and also a global network of buyers and sellers. Recently, it made an investment in a company called Purple Wave to expand its addressable market. We'll get into some of that. But I wanted to introduce the CFO, Leah Stearns; and the Director of Investor Relations, Owen Sweetenberg. What we're going to do is ask Leah to give a brief Copart 101 and then jump into Q&A.

Great. Thanks, Craig. Great to have everyone here today. So Copart was founded in 1982 by Willis Johnson. He owned a single salvage yard in Vallejo, California. And over the past 40 years, Willis, Jay Adair and now Jeff Liaw, our CEO, have all focused on continuing to drive growth in our business, really principally by investing for the long term. I think what truly differentiates Copart from an investment perspective is our horizon. We plan on arcs of 10, 20 and 30 years. And so the decisions that we make today are really in the best interest. And 40 years ago, we're in the best interest of our customers, principally our sellers and members as well as our industry. So as we think about building out Copart, we have a mass network of over 18,000 acres of land that's principally used for outdoor car storage. Storage is important for us, primarily because our largest seller, which is an insurance company needs storage for damaged vehicles as we transition the title from clean to salvage. Those vehicles starting in 2003 were put on to a fully digital online auction. So for over the last 20-plus years, we have built a large global buyer base for principally damaged vehicles, but increasingly lighter damaged vehicles. So today, we have diversified our seller base from insurance down into what we call Blue Car and our CDS or Copart Dealer Services business. We do have a small consumer direct business as well. But the vast majority of our automotive units come from insurance companies. Blue Car consists of banks, rental car companies and fleets. Those are units that do, in some cases, have damage, but we do have a very liquid marketplace to dispose of them for those Blue Car sellers. And then dealers, principally on the buy here pay here side, that we're increasingly working more with independents and franchise dealers. From a buyer perspective, naturally, the business grew out of the connection between insurance companies and dismantlers. Those are the most concentrated basis of sellers and buyers. We've diversified both sides as we brought in different unit types to the mix. We are seeing exporters, rebuilders and ultimately, more dealers come in. And so as Copart looks to the future, we think there is tremendous opportunity for us to continue to grow on the salvage side but also increasingly on the wholesale side. We've recently added members to our executive team who are focused on helping us build out that wholesale and more consumer-grade experience. And we have a new COO, who comes from the logistics side to help us think about just overall driving efficiency and scalability across our platform as we grow into those segments. So excited to be here. We do think in decades. So it may be a slightly different response to questions than you get from your typical company, but we're excited to be here and talk more about that.

It is a challenge in my role to ask questions focused on decades as well, but we'll try to do that. If you have a question, feel free to shoot it to me via this device, and I'll try to ask that as well. I wanted to start with what happened during the pandemic shutdown to the total loss rate and how that since has recovered and what the implications are for your business of that particular metric?

So during the pandemic, what we saw was a significant constraint on unit production and the availability of shops to repair vehicles. So not only do we see -- while we did see accident frequency go down as miles driven, reduced as a result of lockdowns, we saw constraints in terms of unit production, part availability and labor availability on the repair side or replacement side. So as a result, total loss frequency actually declined for the first time in notable history. And since then, we've actually seen the plateau and return back up to near pre-COVID levels. The reason for that is, if you think about the insurance company's decision to deem a vehicle a total loss, they have 2 key variables that they consider. First is the value of that vehicle, the moment before it got into the accident and the cost to repair, net of what they would achieve at auction. Because the availability of replacement vehicles was very challenged, and constrained during COVID, the price increased dramatically. And therefore, the thresholds were really put under pressure. And as a result, we saw a total loss frequency decline. As unit volume has returned to more normalized levels in terms of new cars sold and used car availability, used car pricing has actually stabilized and come down to more normalized levels, and that has caused our insurance partners the opportunity to look at a more normalized basis for how they think about total loss, and we're beginning to see that rate increase again.

So one thing that we got right in the pandemic shutdown and the aftermath is that we thought volume would come back because the total loss rate was artificially low. What we got wrong was thinking that, that drop in price would impact your average selling price and sort of the fees that you generate. But instead, you've held firm on ASPs. And I'm wondering why is that?

So when a total loss frequency increases, the borderline unit that previously would have been repaired falls into the total loss bucket. Those are primarily higher value units. Because if you think about it, if you have a $10,000 vehicle, it has an $8,000 repair bill, and you decide to total that, that the net salvage would be about $2,001. That's when you would make the decision to total a vehicle. So you now have a $10,000 vehicle, and it's even more expensive to repair. The -- sorry, say you have -- you bring down your threshold to -- you increase your threshold to 21% instead of 20%. You're increasingly throwing higher value units into the mix. And as a result, our ASP naturally has a [ boie ] or a floor, and it's increasing as we're getting more and more units that are lighter damaged and inherently higher value.

A few other trends, big picture, if you're thinking in terms of decade. One is EV, the other is ADAS. Maybe touch on each of those topics and how that impacts your overall volume and business trends.

So ADAS is something that I think people when they hear it first think that will certainly bring down frequency of accidents. What we have found is it actually has driven an increase in accident severity, which is the underlying cost to repair a vehicle once it's been in an accident. The reason for that is because the components required to make a car -- or for a car to have ADAS are extremely expensive to repair. And we found that the cost of the parts as well as the labor availability and the cost of that labor are continuing to increase. So that has effectively -- while ADAS is great for helping to reduce the frequency of accidents, we found it has significantly increased the cost to repair vehicles. And as that is a key driver of the decision for carriers when they think about the net return that they get from their salvage if it's going to be much more expensive to repair a car that has ADAS that may be more likely to end up in a total loss bucket. In terms of EVs, though -- I wouldn't say there is -- it's necessarily a function of the car being an EV, but EVs tend to have a lot of ADAS components embedded in them. And that is another factor that we see in terms of EV as having a higher frequency of being totaled than a traditional ICE vehicle. The other element is there's a lot of interest in the battery value. And so as long as the battery is intact, there is a significant value that we find from EVs that is being driven by that component of the car.

Leah mentioned vehicle complexity. And over the last 10 years, we've observed the number of parts required to fix the vehicles increased by 50% directionally. And the number of hours it takes has increased from 25 hours to 30 hours. So adding half a day...

That's -- that is I hadn't known that statistic, but we certainly see it when we look at what repair bill costs look like today. I wanted to ask about land. I mean, I think of your business big picture, the moat is this tremendous land portfolio, you've acquired over 40 years and then this tremendous buying network, which is a huge asset for your insurance companies as you try to maximize proceeds. On the land piece, what drives the decision to invest in more property? What makes for the best location? And how do you optimize capacity utilization, so you can be more efficient with the property you own?

So I think about land in 3 categories. First is capacity. So we're always planning. Because of our long-term horizon, we're planning 5, 10-plus years out in terms of our future capacity needs. That is a function of our expectation the total loss frequency will continue to grow. So while today, it's about 21.1%, we do believe that it will continue to increase over time. And so as we project out by market, by carrier, we know their current total loss frequency thresholds that they're using. As we project growth and our capacity needs for each market, we'll identify specific areas in the next 1, 3, 5 years, where we will need additional land. So that's first. Second is cost from a logistics perspective. So if you think about the number of nodes you have in a logistics network, the increased frequency of those nodes reduces your cost for transport. And so that is a key component of our underlying cost structure. And in the instance where we have a market where we've seen massive population growth, say, south of the city and we do not have a facility south of the city, we'll anticipate the need of splitting the number of storage locations we have in that area to ensure that we're positioned to capture that volume in a cost-effective manner. So we're constantly juggling between capacity and cost. Those are 2 key drivers of our prioritization. And then finally, cap needs. So there are parts of the country that are acutely prone to catastrophic events. We have thousands of acres of stores dedicated for those events. And those tend to be in areas where we can get hundreds of acres dedicated. And this land is not easy to permit. And so I think part of the reason why it does create a strong moat for Copart is that once you have entitlements, many of these entitlements are grandfathered in. If you lose them, if they are transferred to a property owner who does not protect them, you could lose them. And so for Copart, we do believe we have responsibility for our industry to be stewards and own land because if a land owner decided that the highest and best use was an industrial warehouse or a residential development, we've seen that happen to storage inventory in the past. And so we'll continue to also think about it from an industry stewardship perspective to make sure that we're protecting inventory for outdoor storage.

When we responded to the devastation of Hurricane Harvey in Houston, we ended up leasing what was formerly Texas World Speedway to store tens of thousands of units there. And if you go to Google Earth today, you'll see that that's a residential development flush with pickleball courts. That's what can happen. If you don't own your land.

That is interesting. So listening to the last few conference calls, and they are always great calls because you leave a little breadcrumb here and there for the long term. But Jeff has talked about conversations with the insurance industry through maybe investment or through partner conversations that you've had. What are the pain points for your insurance customers? And what are you ultimately trying to solve in the future?

So each customer is ultimately different. They have different priorities year in year out, but we have seen that cost pressures have put a significant amount of focus for our customers around managing costs within their claims organizations. So we think about it in what are the top priorities for them, whether it's cycle time. They have significant advanced charges that they accrue on these vehicles. So if it takes multiple days for a vehicle to get to a preferred shop, all of that storage is accruing and ultimately is waste in our opinion. So how can we help them reduce the waste in their current claims process to get a car more quickly to Copart and alleviate those unnecessary and unwarranted costs. Each carrier is different. We try to benchmark them and show them best practice and where we see best net salvage returns being generated. We partner with our customers to make sure that we help them make better decisions. We can take a postmortem view for them and ultimately help them appreciate where they made the right decision. And if they didn't make the right decision, what was the cost of that error. And that ultimately has helped us really unpack for our customers, areas where we can go deep into their current process and identify significant ways to save them money in addition to getting the benefit of the strong auction liquidity that we provide them at Copart.

I had a question here really goes to your market share. Copart has gained a fair amount of share with insurance companies in recent years. How sticky is that relationship?

So we look at our position in our insurance business as being something that we don't take for granted. Many of our customers are under long-term contracts, but we don't take that and allow us to sit back and enjoy the ride. We're constantly leaning in and making sure that we deeply appreciate our customers' needs, that we're solutioning around them to provide them real value. So I think there is a strong customer relationship that underpins our position, but we certainly do not take that for granted.

So the salvage business, we've been talking about maybe 80%, a little less of overall volume, I think, for Copart. The noninsurance piece, as you sometimes call it is the other big chunk, but that has several categories. Could you maybe rank where you're most excited about some of the growth opportunities you see outside of insurance?

So what's exciting to see within our Blue Car segment, which again is our finance, rental and fleet sellers is that they have unique needs that are embedded infrastructure, whether it's real estate or logistics capability or our technology solutions can solve. And that has been a great tool for our sales organization to go to those sellers and help them solution around key challenges that they're facing within their current remarketing organizations. For example, we have finance sellers who deal with a very complex process to extract units from inbound yards. We've been very successful at tackling that for them. Similarly, we have rental car companies who have cars that have been out on a -- with a customer and they've been damaged. That car ultimately, the financial decision around whether or not they repair that car is very different than an insurance carriers because they're losing revenue every day that the car is not getting repaired. And the higher level of sophistication in these vehicles does cause a much higher cost to repair and a longer duration of repairs, as Owen mentioned. And so in turn, what we're seeing from rental car companies since they self-insure is that they are "totaling vehicles" at a much higher total loss -- equivalent total loss frequency. And those vehicles are getting good liquidity and demand at our auctions. What they don't have from a rental company perspective is storage. A lot of them are in constrained space environments, and so we can give them -- we can provide them storage while we're auctioning the vehicles to our global buyer base. So there are things within our existing infrastructure that we can leverage today to solve those problems. The big, exciting part is moving that to the next level, continuing to go after lighter damage, higher value units and how we can build that out. And so we've recently brought on new members of our senior leadership team who are really acutely focused on making sure that we're developing the right solutions for a broader member base to consistently buy from Copart, those clean title wholesale units.

So I wanted to shift gears and talk about Purple Wave. Give us the structure of that investment and the 10-year strategy behind making that investment?

Sure. So we had done something similar with Powersports back in 2017. We bought NPA, and that's been a nice part of our unit type diversification. We've always watched specialty Copart sells a lot of special -- damaged specialty equipment today on behalf of our insurance sellers. But we had met Aaron and his wife Suzy on and off over the last decade as they had raised capital through a couple of different rounds. And I had always had tremendous respect for them. I think Aaron found himself in an opportunistic position because he felt like it was -- the market was right for him to lean in with the right partner. And so we have effectively purchased 80% of that business. And we have a path to full ownership in the long term. But ultimately, we want Aaron and Suzy to have a lot of alignment with our objectives. And I think we're extremely well aligned, which is that we want to grow that business, and we believe that with the brand of Copart and the balance sheet that we bring to the table, they are going to be able to really take what is principally a Midwest wholesale pure sale off-prem specialty auction and expand that nationwide. And so we're excited to see the initial progress the team has achieved. They're primarily today focused on expanding their sales force and making sure that from an operational capability perspective, we are integrated to the extent that we can help them with winning any of those new accounts and bringing on those units. But they're 100% focused on growth, and we're excited to partner with them to do that.

Could you describe the competitive landscape and maybe the options for remarketing that your customer may have, if it's not just auction, it may be something else?

Sure. Historically, a lot of the heavy equipment, agricultural machinery type units have been sold through on-prem options. Increasingly, those are moving off-prem or moving to higher frequency auctions that are happening more than once a quarter a year. And that's primarily because these units depreciate pretty rapidly, and there is a high cost of transport for these units. So ultimately, to the extent that you can inventory them off-prem, you can save the seller a significant amount of money. And ultimately, if they're looking at it from a net return perspective, that's a big advantage. So the alternative is there are large fleet companies that defleet units. They could certainly sell that themselves handsell that. But what we found is that the industries around specialty equipment are conditioned to buy and sell used equipment quite frequently. And so there's a high level of turnover. And so that's what we're excited about because there's a nice pocket of addressable market for us to go after.

When I think to your salvage business, the moat, again, it's land, it's the network. When I think of Purple Wave, it's really more about the network than it is about land. Is there ever an opportunity for you to maybe leverage Copart property in some markets to take care of custody and control of those assets? Or are we overthinking maybe the strategic value of that?

It's certainly something that we can offer them, but it's not our principal objective. Our -- what we love about the Purple Wave platform is that they have effectively sold the off-prem model and pure sale model so that when someone lists with Copart -- sorry, when someone lists with Purple Wave, they're going to sell at [ Purcell ]. There's no reserve. And that is something that is, I think, unique and important to appreciate. It is a pure liquidation. And you tend to see buyer activity be much more robust in those types of auctions. So maybe there's an instance where they have a large institutional seller where in pockets of the country, they need to leverage some real estate. But ultimately, that was not our principal thesis behind why we want to partner with Purple Wave. It was -- we believe this is a market where their buyer -- their approach to building a buyer community and their value proposition to both sellers and buyers has been very successful, and we believe it can be replicated out to the coasts.

How would you frame the total addressable market opportunity Copart sees when having made that investment, you chose to do that?

Well, we definitely have -- there -- it's a very fragmented market after you get past the leading player. And so we think that there's a lot of opportunity for us to leverage the relationships that we have with fleet companies. There are relationships that they have built with the network of dealers and other sellers that they have within a certain geographic range. But some of this is really about bringing on leading sales force, folks who have existing relationships that we can leverage to expand into what we believe is a really nice addressable market that will complement our existing salvage specialty business at Copart. A lot of what we did with NPA by bringing in a wholesale business, complemented what we did on [ crush toys ], and this is a similar opportunity in specialty.

You mentioned a few executives that you've added recently to grow the business in different dimensions. Just talk about their background and what specifically they have been tasked to do?

Sure. So I'll start with Dave Kong. He's our Chief Marketing Officer. He joined us from Capital One Auto Finance. Dave is principally focused on helping to build out our member base to support our wholesale initiatives. He is also focused around the rest of Copart. But if you think about the one unique element of his remit that's broadly new, it's really to enhance the buyer base that we have to build further auction liquidity for wholesale units. Our Chief Product Officer, Neel Madhvani, came to us from Chewy. He is principally responsible for a product and our portfolio of product development at Copart. The area of focus for him that I think is unique is really making sure that we're pushing the persona experience that each individual buyer type has with how they integrate and interface with Copart on a dot-com experience. And so he is working with our sales, marketing and tech teams to make sure that we have the experience necessary to be present, not just for dismantlers, which I think we have now, but also move down through the more fragmented base of buyers, which includes dealers and consumers. And then finally, Hessel Verhage, who is our new Chief Operating Officer, came to us from DB Schenker. He's worked his entire career within logistics, and that is a large part of our operating platform that we are focused on driving further efficiency through. So Hessel has brought a lot of great energy around how do we think differently about logistics and also just broadly our operating scale and how we maximize that.

Question on your international strategy. Could you give us an update on what's happening in Europe, specifically in Germany and how you intend to grow that business?

Sure. So shortly after I joined Copart, I had the opportunity to go over to Germany and meet the team. We spent a lot of time thinking about how do we drive better operational optimization of what's happening within the business today, absent additional future growth. There have been some great strides made and progress made within that business. I think the team is doing a great job executing across multiple vectors from a revenue opportunity perspective with insurance, with our Blue Car sellers in Germany as well as really focusing on maximizing the embedded infrastructure that we have and optimizing costs. So I feel great about the progress that they've made. And in addition to Germany, we have a great business in the U.K. That's a business that we've seen some nice share gains. And we've been investing pretty aggressively in real estate to ensure we have the capacity to support that before the winter season picks up. And then finally, we do have a broader base of markets. We're in 11 markets globally. And I think we continue to think that international provides a nice complementary element of diversification to our business and that there are markets where you have high GDP per capita. Those are markets where you typically have OEM inventory being manufactured, sold. That's the type of inventory that our global buyers are looking for from a salvage perspective. And so we'll continue to look at international and see if there are further ways for us to grow both organically and inorganically.

We've got the CFO. So let's talk about the balance sheet. What are your capital allocation plans? Maybe tell everybody what balance sheet looks like and then what your plans are for cash?

Sure. So today, Copart has no debt. We hold about just over $3 billion of cash, and we have over $4 billion of liquidity. We are incredibly patient investors. Again, I think at the opening, something you'll probably feel is different about us is our investment horizon is 10, 20, 30 years. And so we're incredibly patient about how we deploy that capital. We have very high expectations in terms of the types of returns we'll achieve with it. And therefore, as a result, we have built a fairly fortress-like balance sheet over the last several quarters and are currently principally investing it in U.S. treasuries, and we'll continue to look for ways to invest, whether it's into further expanding our capabilities, our real estate portfolio, our technology. We do have an active M&A program. We are always looking for ways to expand our presence and our capabilities. If it's faster and more efficient and a better return to do it inorganically, we certainly will pursue that, like we did with Purple Wave. And then finally, we do and have had active buyback programs in the past. But again, we will be incredibly patient and targeted in how we execute on our capital allocation strategy.

Perfect. Well, listen, we had a lot of questions. We didn't get to ask all of them, but you are available for a further conversation in our breakout session. So Owen and Leah, thank you for being here.

Thank you.