CPRT - Copart: Neutral As Profit Margin Expected To Be Flat

2023-07-24 11:07:07 ET

Summary

• Copart's 3Q23 sales grew by 8.7% to $1.02 billion, with the company's adjusted EPS increasing 22.4% year over year to $0.72.
• CPRT should continue growing the revenue line in the hsd to the 10% range. However, net margin is expected to remain flat at 31%.
• Based on my model, at 33x NTM PE, CPRT seems to be fairly valued. Hence, I recommend a hold rating.

Summary

I am recommending a hold rating for Copart ( CPRT ) as the valuation is not attractive at this level. While positive growth indicators and continued revenue growth support the company's prospects, I have concerns regarding the margin trajectory. I would, however, turn more positive if the mix shift impact towards a low-price/high-volume mix ended up being net positive from a margin perspective.

Company overview

Copart, Inc. provides vehicle suppliers, primarily insurance companies, with a variety of services to process and sell salvage vehicles through auctions. The Company offers salvaged vehicles that are primarily sold to licensed dismantlers, rebuilders, and used vehicle dealers. Copart serves customers worldwide.

Financials / Valuation

With an increase in both service and vehicle sales revenue, CPRT's 3Q23 sales grew by 8.7% to $1.02 billion. Operating margin rose 13bps to 41%, as gross margin rose 90bps to 47.3% due to a shift in the US mix toward higher margin consignment units, and G&A expenses fell 50bps year over year to 6.3%. The company's adjusted EPS for 3Q23 increased 22.4% year over year to $0.72, which was higher than the consensus estimate of $0.64. Aside from 3Q23 results, CPRT balance sheet is worthy of a mention as the business has remained in a net cash position since 2018. I believe this gives it considerable flexibility in conducting M&As or invest in the business when necessary. This compares well to OPENLANE, Inc. ( KAR ) which is in a net debt position.

Indicators of growth suggest progress; according to the 3Q23 earnings call, the number of insurance units in the United States rose by 6% annually in the wake of a continued uptick in TLR) of 19% and gains in market share. The fact that management estimated that volumes could have been 10% higher in a pre-covid environment with 20% TLR suggests that there may be more room for recovery beyond what was seen in 3Q23. One more piece of good news is that it appears that international sales and entry into the US whole car market will be the next growth levers to pull. CPRT's continued volume growth in its more established markets, such as the United Kingdom and Brazil, contributed to a 9% increase in revenue from international services. Newer markets, such as Germany, Spain, and Finland, have also been performing well, according to management.

Based on my view on the business, CPRT should be able to continue growing the revenue line how it has been growing in recent quarters given early indicators are positive. I modelled revenue to grow 9.6% in 2023, 6.9% in FY24, and 8.6% in FY25. However, I expect net margin to be flat at 31% for the coming 2 years as CPRT trades off between high price / low volume mix to low price / high volume mix.

On valuation, I believe CPRT (trading at 33x NTM PE) deserves a premium to its main peer, KAR, who is trading at 27x NTM PE. Reason being, CPRT is a much larger business which means it has much significantly larger scale, and also CPRT has better margin profile.

Suppose CPRT continues to trade at 33x, I think the stock is at max fair valued give my target price of $95.

Comments

With historically strong pricing, CPRT performance has been marked by margins above and beyond what was expected. On the other hand, the volume of damaged vehicles being repaired rather than salvaged has led to higher performance levels than would have been expected in the absence of the COVID-19. Management emphasized this latter point on the most recent earnings conference call in May, saying that total loss frequency in the quarter would have been similar to pre-COVID levels, which would have resulted in US insurance unit volumes being +10% higher than they actually were.

I anticipate long-term TLRs to exceed pre-covid levels due to sustained repair cost inflation with increasing vehicle complexity, as in my opinion there has been no structural change to the industry dynamics (the fundamental action of buying and selling cars via auction for insurance companies remains the same). Recent trend levels (from 17% in 2Q22 to 19% in 1Q23) indicate a continued volume tailwind compared to current depressed levels, suggesting that TLR will gradually trend to more than 20% in the near future.

Meanwhile, management has been emphasizing BlueCar & Dealer Services as a means of expanding CPRT's total addressable market, which stands to benefit from the company's large physical auction footprint in contrast to its primarily digital rivals. Overall, from a long-term perspective, the business seems to be on the right track

Playing devil's advocate, I also detail why I believe it is best to maintain a neutral stance on the stock for the time being. CPRT has benefited greatly from the current market climate, which is characterized by unusually high prices and low volume. In the five years before the pandemic, the CPRT all-in agency model generated a gross margin of 40+%. However, with gross margin expanded to 50++% in the covid years, CPRT generated a record $1.37 billion in EBIT in FY22, significantly higher than the previous pre-covid record of $717 million. I think CPRT's growth can only be explained by the positive effects of a drastic change in the company's revenue mix, away from low-margin high-volume contributions and into higher-margin high-priced ones. The issue is that CPRT will suffer margin contraction when the opposite occurs (higher volume at lower prices).

Risk & conclusion

The supply shock caused by the COVID-19 pandemic and its aftermath, including the global semiconductor chip shortage, may cause used vehicle prices to fall more quickly than initially anticipated. This could have an adverse effect on CPRT's bottom line if volume doesn't pick up as fast as it should.

In conclusion, it is recommended to adopt a neutral stance on CPRT at this time. The company has shown progress and growth indicators appear positive, with continued revenue growth expected in the high single digits to 10% range. However, there are concerns regarding margin trajectory, which I expected to remain flat due to the shift in mix towards a low price/high volume model. While I believe CPRT deserves a premium valuation compared to its main peer, KAR, the stock seems to be at its maximum fair value at the current trading level of 33x NTM PE.

For further details see: