Copart Auctions, A Little Outlet For America's Car Problems

Key Points

• Shares of Copart reached an all-time high during the after-market hours of Wednesday evening, amid the company reporting its second-quarter 2023 earnings. 
• Increasing car repossession rates provide an inventory influx source for the company, with sustained unaffordability in the car market boosting the number of customers that choose Copart as the alternative market outlet. 
• Management points to sustained organic growth, an attractive capital structure, and cost-reduction initiatives through technology implementation. 
• Though analysts imply the stock is fairly valued, some fundamental factors will uncover additional value in the stock price.

Shares of Copart NASDAQ: CPRT reached an all-time high price of $82.81 in the after-market hours of Wednesday evening, amid monstrous momentum buildup throughout 2022, seemingly continuing into 2023, as showcased within the company's second quarter 2023 earnings press release. The overwhelming rally in the stock comes as other companies in the space, such as Carvana NYSE: CVNA and CarMax NYSE: KMX, are experiencing sell-offs of up to 90% in their respective prices, stating the operational strength that Copart offers investors looking to navigate the current vehicle industry.

During most of 2022, and to some extent 2023, the United States vehicle market experienced challenging dynamics. As semiconductor shortages affected car manufacturing output, supply chains were severely disrupted, creating bottlenecks and delivery delays for would-be new car buyers.

This shortage and extremely long wait periods for new vehicles drove consumers to find alternative purchases within the used car market, which subsequently went prices beyond value comprehension due to systemic demand. Today, Copart has established itself as a solution to some of the challenges buyers face in the U.S.

The Dominoes Fall

As interest rates rise, cheap money runs out, and the FED raises interest rates to fight inflation. Unemployment begins to rise; there is a spike in the rate of car repossessions nationwide. Bloomberg reported that delinquencies facing car notes were rising at clips not seen since the great recession 2008.

For reference, auto delinquencies larger than 60 days were only 5.0% in 2009. In contrast, they stand at 5.7% today with no signs of slowing down. Now that all of these vehicles are beginning to fall under repossession, the question becomes, where do they end up?

As part of its diverse inventory, Copart carries vehicles from places like insurance companies, rental car agencies, and repossessions. As the COVID-19-related lockdowns took a toll on the average citizen's income, non-essential payments like car notes and credit cards were the first accounts to fall behind. T

hese trends can be spotted within Copart's financials, where inventory levels rose from $20.1 million in 2020 to $58.8 million in 2022, implying an influx of units to be reported. Investors must remember that this inventory level increases feed directly to the company's value, and most of these vehicles are written down in value. 

As these trends continue to develop, further repossessions will fuel Copart's inventory levels, and the extended delivery times and unaffordability within the new vehicle market will fuel Copart's sales. Copart finished its second quarter 2023 posting an 8.7% revenue increase and a 25.8% advance in net income subsequently. More importantly, investors experienced a 24.1% increase in earnings per share to finish the quarter at $0.72.

Hidden Value

During the earnings call with executives, an M&A (mergers and acquisitions) question was raised, pointing to the company's $2.1 billion cash balance at the end of the second quarter of 2023. Management means there is no need to look for or consider acquisition targets, considering that organic growth prospects are as resilient as ever, especially given the current vehicle market dynamics.

With more work to be done in a technological sense, Copart is looking to boost margins through cost-reduction initiatives. Finishing the quarter with a near 41% operating margin, Copart has achieved proper reductions in expenses (as a percentage of revenue), such as the cost of vehicle sales. In addition, as more technology is implemented into Copart's sales process, there is an increased revenue retention factor as the process becomes more streamlined.

Today, Copart's analyst ratings point to the stock being at fair value, with even some tiny downside. This would seem to be a conservative view, considering the massive tailwinds the company can count on as the national economy shifts from overheating to a cooling cycle. Increased repossessions boost inventories and sales. Operating margin boosts via technology and a favorable capital composition of virtually no debt point to a clear path of free cash flow generation.

As the company is just coming from its 'growth stage, ' investors can expect these newly found free cash flow levels to be allocated toward even more optimization, share repurchases, and even a possible dividend payout. A good indicator of these times to come is the amount of stock-based compensation the company decides to pay out. In 2019, stock-based compensation was 37,797 shares; as of 2022, that number looks below 25,000. Reducing stock-based compensation frees up more cash flow for investors and reduces the diluting effect of outstanding shares.