Chit Chat Stocks - Copart (Ticker: CPRT) with Leandro From Best Anchor Stocks

Episode Date: May 11, 2023

Copart, Inc. (CPRT) is an online vehicle auction and remarketing company that provides a platform for buyers and sellers to transact vehicles, with a focus on salvage vehicles and parts. Listen as Brett and Ryan ask questions about the company, its business model, and valuation. Enjoy the show! ***************************** Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney  Subscribe to our Substack to receive free show notes and charts that go along with every episode: https://chitchatmoney.substack.com/ Interested to see more of Leandro's work? Check out their Twitter here: https://twitter.com/Invesquotes?s=20 Contact us: [e-mail] Timestamps Copart | (2:08) Customers | (13:22) Stock Buybacks | (47:32) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. My name is Ryan Henderson, and I am joined by my co-host, Brett Schaefer, as always. Today, we've got our Thursday deep dive episode. On this episode, we interview an analyst to discuss a single stock or industry. Today, we have on the show, Leandro, and we're talking about Copart. Leandro has been on the show a number of times, so people that are regular listeners might be familiar with some of his other episodes, but he seems to be a fan favorite. As all the episodes that he's come on and discussed companies, we've gotten really, really strong listenership numbers on those. So people must love him for a reason. And we enjoy listening to him every time we talk to him. And Copart was no exception. So I'm excited

for you guys to hear this one. No ad today. So without further ado, here's our interview with Leandro. Welcome to Chit Chat Money. On this show, hosts Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or a recommendation. Now, please enjoy this episode. All right. Welcome to Chit Chat Money. Today, we did the math right before we came on. I think

four-time guest, Leandro from Best Anchor Stocks. He's the author there. Go ahead, check it out. You're probably familiar with him if you've listened to the show on a recurring basis, but I think in our past episodes, we've discussed Adobe, Constellation Software, and ASML. We're going with another, I guess, maybe you could call it high moat business regarded as high quality. So I guess before we dig into Copart, which we're going to discuss today, I always kind of find it fascinating to see how people come up with their ideas. So how'd you come across Copart to begin with?

Well, first of all, thank you for having me, Ryan and Brett. It's nice to be here for the fourth time. I think actually the last one was a few months ago, so it's great to be here again. So if I'm honest with you, I don't remember exactly how I came across Copart, but I think it was thanks to Chris Mayer. So sometimes I source ideas by looking at the portfolios of investors who I respect. And I think this might be one of those times. So of course, I don't simply blindly buy it after, but the portfolios of people who I respect are actually a great source of idea. So that was step one. Then the first thing I did was buy the book from the founder, Willis Johnson, which is called From Junk to Gold. So not only I found this book

entertaining, but also a great reflection of the founder's vision, which obviously still lives today in the company because he's still involved. He's not the CEO anymore, but he has a significant stake. So after reading that book, I decided to start researching the company. So I think the company had some characteristics that were appealing from the start. So it operates in a boring, oligopolistic industry with very high barriers to entry. and it has a long runway ahead. So I think just those characteristics

call for a closer look. And it's also not the typical company that makes headlines. So it's actually very tough to come across it just by scrolling news feeds. But I think that in fairness, this is something that I like about it because it's easy to hold.

So for many companies, you are going to face a continuous stream of news, but this is not the case for Copart. So separating the signal from the noise in Copart's case is pretty easy because you only get news actually like every three months because you're getting the earnings. So I think that's an underrated advantage for any investment because it actually helps investors focus on the company and the long term. Yeah, I agree. I love the companies that we have that don't really seem to care about the quarterly stuff or give us sort of just what we need to know always makes me fret or worry a little less. But I guess let's go through Copart's business model. You mentioned some of the characteristics there. We can talk about those in a second. But can you give us kind of the basics? What does Copart do? How do they make money? And then maybe talk about the different stakeholders within their business. Yeah, so Copart basically operates on online auction platforms where sellers and buyers come together to transact salvaged cars. There are also cars that are not salvaged cars, so used cars, but the majority of the volume will be salvaged vehicles.

So it's a two-sided marketplace and you have buyers on one side and sellers on the other side. And Copart is basically the enabler of the transaction. The sellers are primarily the insurance companies. So when a car is in an accident, it triggers a decision-making process for the insurance company. And there are basically two outcomes. One, does it make sense to repair the car? Or two, does it make sense to total the car and pay the pre-accident value to the customer? So you basically have to make a decision between those two.

The pre-accident value is what the car was worth before the accident. So the decision is actually based on a mathematical formula, and it's also important to understand that the insurance company is always going to lose money after an accident, but they are going to try to choose the option based on where they suffer the lowest economic loss. So, for example, if the repair costs are higher than the difference between the pre-accident value and what the insurer can make for the total car at auction, then the insurer will choose to total the car. So the rationale in this particular scenario is that the insurer loses less money by totaling the car, paying the pre-accident value, and then trying to make up for, I don't know, $3,000 or $4,000 through auction. This might be a bit confusing just for listeners, so I'm going to give a brief example with numbers. So let's imagine that the repair of a car costs 8K, okay, so $1,000. Their pre-accident value is $10,000, and the insurer could recover $3,000 at auction. In this case, totaling the car is the preferred scenario because the insurer is only going to lose $7,000 because they are going to pay $10,000 in pre-accident value, but then they are going to make $3,000 through the auction.

um so that that when you net those that gives you seven thousand dollars so obviously losing seven thousand dollars is better than losing eight thousand dollars that cost to re to repair the car so when when the repair costs are higher than the pre-accident value minus the auction value then that car ends up in copart because copart is responsible for for the auction or Or the insurer will sell that car through Copart or IAA, whatever of those two, or maybe through a mom-and-pop shop, but probably through those two. And then you also have the other scenario where imagine that repair costs are $5,000. The pre-accident value is $8,000, and the insurer can only make $2,000 at auction.

In this case, the difference between the pre-accident value and the auction value is $6,000, but the repair costs are just $5,000. So in this case, an insurer will say, okay, I prefer to repair the car because it only cost me $5,000. And the other scenario is $6,000. So there are, of course, other sellers like charities and financial institutions. So for example, if a financial institution has a car as collateral for something, and that car ends up with a financial institution, In many cases, they will choose to sell the car fast through co-partner IAA and get money for it. But well, the majority of the volume is driven by insurers. This is just the sellers. Do you have any questions? Because the buyers is much easier to understand, I think.

No, I think that's good. Makes sense. Yeah, that makes sense. And so just to kind of rehash, it's The post, after an accident, insurance companies basically take the car, assess the value, see whether it's better to repair or total it. And then if it's totaled, it typically goes to Copart. And I guess we're going to talk about competitors in a second, but is it kind of, is Copart kind of the primary player here? Or do they kind of, do they have existing relationships with Copart or do they like auction it off or like, are they bidding one of the auctioneers against the other auctioneers? I'm curious how the competitive landscape works there. Yeah.

So there are two main players in the industry, Copart and IAA, which is insurance auto actions. uh these two players make up like 80 of the volume of the interest in of the industry and the remaining 20 is mom and pop shops that have like independent yards and historically this was evenly distributed across both players but lately we've seen copart take a share from iaa for example the IAA lost Geico as a customer and the volumes went to Copart and actually it's funny because reading the IAA earnings call from the moment that happened management was quoting the volumes net of a big customer loss so that was like a huge red flag for me it's like saying yeah volumes are are up four percent excluding the loss of this customer well obviously you need that

customer because it's a very concentrated space, the seller space for these companies because insurance companies are typically very large. So the relationships are really, really important. And I think that's where Copart has made the difference with respect to IAA. So yeah, I don't know how you can report revenue excluding customer losses, but logistically here it's copart has basically these yards that the insurance providers bring them to is that kind of what i'm getting so so copart has like a comprehensive service that signs like long-term contracts with some insurers so when an accident happens uh then copart will be responsible for

everything from that moment so towing the car to their facility putting it in the on the action page and then they'll obviously insurers will pay for this for this service a fixed amount and then copart is just takes care of takes care of of everything so that's how it goes it's not like the the the car stands at the insurer and then they simply auction it that car has to end up in one of copart's yards and then from there they take the pictures and they put it and put them to auction so one little follow-up on that how do they manage the inventory on the balance sheet is it difficult or do they have since given their size is it not really an issue for them because i kind of think similar and obviously they're not in as big as trouble as carvana but it seems similar

to me where you have to take a little bit of inventory risk and it might not be as bad because they're salvaged stuff but you have to take the inventory and then sell it off is that any sort issue or is it really worked but they're not the buyer yeah that's yeah are they not they don't take they don't take the yeah they don't take the ownership of the car so um but even if they don't like it doesn't appear in inventory having a car stand for too long in your yard that's also an expense obviously because that car is taking the space yeah it's like phantom inventory almost am i getting it right okay and but the rotation like i wouldn't be worried here because the rotation is quite fast. Actually, one of the main limitations of the inventory getting sold

is the regulation that happens before you can deem a car a total loss. So until it gets the salvage title, that's actually pretty slow. And if they could speed that up, then Copart would rotate the inventory faster than it does now. Interesting. Interesting. Okay. Now let's go through the buyers i'm assuming they're used maybe junk i don't know what they would be you tell you tell us what what it would be and is there any other big parts of the business that investors should be aware of so so buyers are much more a much more fragmented group uh you can find here car dealers dismantlers rebuilders or even the general public like you can go on copart and maybe find a car that you like and you think that you are going to be able maybe it's not in salvage

condition and it's just a used car and you can and you can buy it um of course it's it plays to copart's strength that the buyers are fragmented because they don't have leverage against copart so one of the main criticisms that copart copart gets is that it treats sellers very well but it doesn't treat buyers as well and while i think this might be true like most of the fees are made with the with the buyers but um this makes sense like if you have a seller group that you your inventory or your volume depends on that seller group then you're going to do whatever you can to add a lot of value to them but if you're and if you're your buyers are going to be there because you have a very good inventory like that's your value add for the buyers like

i'm a a rebuilder i need this part and i know that copart has a car that has this part so then I'm going to go to Copart and I have no choice because if that car is in Copart, I'm not in IAA, then I have to go to Copart to get it. So obviously Copart focuses on the sellers because it makes much more sense for them. I don't think they treat the buyers bad, but obviously most of the money is made through the buyers. And when the price increases are made to the buyers mainly and not to the sellers. All right. Yeah. That's a great overview of how the business works. Let's go through the financials, though. Just walk us through that.

What are their costs? What kind of margins do they generate? I'm curious because this is such a unique business model, what their major cost structure is. And then if I can add one more, and I think, Leandro, you're maybe about to touch on this. How do they, do they just take a percentage of kind of the difference? Is that the majority of their revenue? Okay. So the company makes money through several ways.

the most relevant is service fees and these service fees they as the enabler of the transaction they take a fee based on the transaction value so the there they will take a higher fee if the car is being sold for seven thousand dollars than if it's being sold for two thousand dollars and they also take other fees for example buyers to buy on copart you need to pay a subscription so they also take that then sellers also pay copart to take care of all the towing and all the services the additional services so that's the most of the revenue and then they but but copart also has a smaller revenue stream that is purchased vehicles revenue so from time to time copart will go to the market would they will buy cars and then they will resell them at a higher

price and they typically well they do this for for two reasons the first one is because sometimes when the used car prices are high pre-accident values are going to be high and the total loss ratio so the cars that end up going back to the mathematical formula that we talked about for the insurers is going to be to make the probability of a total loss lower when the high used car prices are when used car prices are higher because obviously it makes more sense to repair if the pre-accident value is very high. So sometimes to make up for that loss of volume, they'll purchase cars to have a good inventory for their buyers. And the other reason is also because Copart, when it's going into international geographies, this model, the service model is

very established in the US, but in other geographies, it's not. So to convince the insurers, for example, in Germany, Copart is taking ownership of the car and reselling them on their webpage just to tell the insurers, hey, look, this model works until these insurers trust it and then they switch to the service model. So those are the two revenue streams, but service fees made up around 80% of sales in 2022. So that's the majority of the revenue.

Makes sense. All right, and the financials, I guess, any relevant context there that you have to share with the listeners and what are their primary costs? What leads down to that net profit margin or cash flow margin? So just to get a grasp for people that don't know of Copart's size, the company generated around $3.5 billion in revenue last year. The growth was very solid in 2022.

It was 30% sales growth. But of course, it was also aided by high used car prices because the transaction value in Copart's platform also goes up. if used car prices go up. I think we can touch on this later of how used car prices impact the company. The pandemic year obviously was a bit more muted in terms of growth because there were less cars on the road. Although actually this is interesting because co-part is a bit also insulated from a recession and the fact that there are less cars because when there are less cars, people tend to speed more. So accident severity can go up during a recession. And well, but even during the pandemic, the company managed to grow 8%. So the company has

basically doubled revenue over the last five years, which is pretty impressive, I think, for such a perceived boring industry, so to say, or boring company. So besides this fast growth, The company also has very strong margins. So the gross profit margin is around 45%. And I know listeners might be saying, well, that's not high. But this is because the most important costs are embedded here, which are the costs related with the JART operations. And these are towing and labor.

So towing and labor are the two most important costs that go into cost of revenue. so they have been seeing increased costs from both of these due to inflation but then obviously there's a lot of leverage in the in operating expenses so they end up with a net income margin of around 30 percent so you have gross margin of 45 percent and then you have net income margin of 30 so that that just tells you that most of the costs are obviously in in cost of goods and so it's obviously a highly profitable company i would say here is something important to bear in mind um is that margins can be a bit misleading when you can compare them to to for example iaa because copart buys the land where it has the like buys it yards and takes ownership of of its yards

and yards are not amortized. So they completely bypassed the income statement. Whereas IAA leases the yards. So they do see those expenses going into the income statement. So I would caution against, well, you can compare them, but you have to make some adjustments. Like if you get the numbers at face value, you'd say, whoa, Copart is much, much more profitable than IAA.

But then when you adjust those numbers, copart is still more profitable but the the difference is not so large obviously this bypasses the income statement but affects the cash flow statement because obviously land is a capex expense and you see that copart spends significant amount on capex and the majority of it goes to land but they still end up with free cash flow margins of around 16 percent which I think it's pretty healthy considering also that they're making these investments in an appreciating asset, which is land. It's not like you're making the investment and you are going to lose economic value. I read some, I forget what blog I read it on.

I think it was, I'm blanking on it, but I read something that when they purchase the land, it's sometimes hard to like get the rights to have a salvage yard. Is that right? yeah so that that's part that's part of the moat because um well copart has been buying land for decades so obviously many cities they they typically buy these these yards in the outskirts of the cities but many cities have grown and now these yards are pretty close to the to the city and you're basically it's basically very difficult to get a permit to have a salvaged yard because nobody wants the salvage yard on their backyard. And they are actually known to be hazardous territory

because you have old cars and there's a lot of pollution from that. So it's actually quite difficult. Maybe you can get yards, but you cannot get them in the same location as Copart has them because maybe Copart bought it 20 years ago. Interesting.

You mentioned the used car prices. I saw on one of your recent write-ups, there's kind of positives and negatives to the used car prices. So can you explain how the changes in used car prices affect Copart's business? Yeah, so when I started researching Copart, my first thought was like, well, this company is going to be like really dependent on used car prices. So it's going to be highly volatile, especially since we've seen a lot of volatility in used car prices coming out of the pandemic. But then when you start to look at the company, you actually see that the company is quite insulated from used car prices in general. So, for example, in the current environment with high used car prices, the total loss ratio, so the percentage of cars that are in an accident and get total is going to decrease because, as I said before,

the pre-accident values are going up so it makes more sense to repair the car so then they see less volume from high used car prices but then at the same time as they take a fee from the of transaction value as transaction values and average selling prices are going up they are making more money because it's it's a percentage um so they are actually quite insulated i i would say that if now used car prices start to normalize, then we should see the opposite. We should see volumes go up because the total loss ratio should tick up and we'll see average selling prices go down. So it's a bit unclear how the company will come out of this period because it's difficult to, and even management has said that they cannot predict what will happen when the used car prices

go down so they know that they are somewhat protected but on the margin side obviously there can there can be an impact because it's more profitable if you're growing in price than if you are growing in volume because volume has a lot of costs as you're associated and it takes this like you incur the same cost if you sell a car for 2 000 or 7 000 in in your platform so it's a bit unclear but they are quite insulated i would say from from volatility in used car prices i don't think growth will fall off a cliff if used car prices come down which they will eventually will probably yeah and it seems like and it's a give and take but they have a bit of a national natural inflation hedge versus their cost if generally i think if their input costs

are rising potentially used car prices are rising as well and they can make up that margin in that way uh but our next topic here i think this is an important one for the industry is comp competition and competitive advantages you mentioned the competitive landscape a bit already if you have anything else on that follow-up please and then i think what people fall in love with with copart are the multiple competitive advantages so any thoughts on that you talked about the land maybe the marketplace all that good stuff yeah so i think the company has four competitive advantages uh economies of scale barriers to entry uh to real estate that we just commented on then network effects and then the customer relationships so economies of scale also have

to do a bit with the yard network so if you have a very large yard network then you're going to be able to optimize this because the most important cost here is towing so obviously the shorter the distance you have to tow the more uh the more profit you can squeeze from that from that vehicle so as we said copart has land close to the cities and that's obviously an advantage that it's very difficult to match and they maybe have a lot of yards that they can take the inventory to so imagine if you're a small player and you have just two yards then you're going to have all your cars there and then when you want to tow them it's going to be probably a long distance so it's like a network of of notes it's actually similar to to amazon in this sense but with instead of with

distribute like fulfillment networks this is with with yards um this the second competitive advantage is the one that we we talked about the the real estate so it's very difficult to get the permits especially in in zones that are close to to cities and then you have the network effects So Copart has millions of buyers on its platform and they are there because Copart has the inventory. So if a company wants to attract these buyers, they first have to have to replicate the inventory, which we have just seen that it's almost impossible because to replicate the inventory, you first need the customer relationships and then you need the yards to put those cars in. so you need both things and and even if you have like the inventory you're going to have to convince buyers to switch because they are used to coparts service level so um and customer relationships i think i wouldn't consider it like a very strong competitive advantage but i would say i would put

it in there i wouldn't consider it moat but i would consider it a competitive advantage because Because insurers are known for not being the most flexible customers. So obviously, it's very hard that they change something that's already working and all the implications that that might have, not only in cost, but also in customer service. So if I'm an insurer, I can be the customer of an insurer. So if the process goes smooth, then I'm not going to switch. but if the process doesn't go smooth then i might be inclined to go to another insurer so obviously they care a lot about the service and that they get so i would say those are the four competitive

advantages which if you ask me are for an upstart they are almost impossible to replicate not only for the regulatory mode also because it requires a lot of money and but if you like if if you ask me about the competitive advantage of Copart compared to IAA, which is a rather large play in the industry, I would say that the difference has been purely execution, but execution for a very long period of time. And for me, that's also a mode. So management that knows the business and has the right strategy, obviously it's a mode because every year they are leaping forward compared to the competitors. So that's why Copart, through execution and strategy,

has provided a much better level of service to insurers than IAA, and that's where they are taking market share. I don't think that they are going to take all the market share from IAA, but I do think that Copart is a much better company operationally and also financially, but that's another topic. You just kind of led us into this question that we got from Twitter. So when we put this out, we got a lot of feedback on questions that people wanted answered. And they mentioned that, which was the relationship with insurance customers if they continue to take market share.

So I guess, do you think there's any concern from insurance customers if Copart continues to take market share? um how do you how do you look at it i guess how do you look at those dynamics okay so right now i would say that there's no concern because it's exactly like it's precisely the insurance companies that are giving the volume to copart so obviously that right now there's no concern but will this evolve to be a monopolistic industry i highly doubt because if that's the case like insurers are not going to give all the leverage to Copart because that can have two bad consequences, in my opinion. First, you are subject to price increases and you basically have nowhere to go. And second, Copart can get complacent with its service levels, which is even worse because then

your customers may leave and go to another insurer. So I think Copart can continue to take market share from IAA, but I do see this as an oligopolistic industry going forward because insurers know that they cannot be at the mercy of one company. And also looking forward, imagine that something happens to Copart, like in a Black Swan event, and then you cannot count on them, then it's going to be, you don't have another option. So I don't think it's going to evolve to our monopolistic industry. Now, I got one follow-up on that. We had a few questions on this from Twitter. So I think we're going to sum it up into one. And it is the acquisition of IAA by, I think the company is called Richie Bros. Correct me if I'm wrong there. Just your general

thoughts on that and how this can affect this industry, because I know that could be, I don't know if it would be disruptive, but it's a big change if IAA goes and becomes a partner with another company yeah so i think i have quite a radical view here because i think it's going to be positive for copart if the acquisition goes through or if the acquisition doesn't go through so if the acquisition doesn't go through iaa has basically said okay we cannot compete against copart because like they are winning we want to get acquired and maybe try to find synergies with another company and and try to to compete that way um that's if we remain in the status quo because i think copart will continue to win there then if the if richie bros ends up acquiring iaa

i think they are going to milk iaa because if you if you listen to the call from the acquisition it's so obvious that what richie bros wants is the land that aaa has for their business like they they are they resell use machinery so they obviously the the land is also useful for them and i don't know if after that call my my feeling was whoa all the synergies possible synergies that you're going to find here they are all going to accrue to richie bros and not to aaa so they're basically going to milk IAA. And this happened to IAA already. They were owned by CAR, K-A-R, if I'm not mistaken, before going public a couple of years ago. And basically, the owners milked the company. They started paying dividends to themselves. And so I think it's going to be,

they're not going to do it through dividends, but I think all the synergies will accrue to to richie bros and it was a bit telling in the in the in that call that the richie bros ceo said that so so before saying this i think the it's not going to work well because richie bros doesn't work with insurers and insurers are the main customer for iaa and copart so you there's no synergy there like they are not going to insurers are not going to want what what richie bros has and it's not going to be easy to penetrate like to go and say hey now now that i'm with richie bros i'm a better company insurers are going to say yeah but i don't care about richie bros like they are not i don't work with them so there's not way to simplificate and the the worst thing

probably was that the richie bros ceo said that she used to work in insurance so that means that she has she has good relationships with the insurers and i was like yeah i don't think that's going to make the difference because the service service is what matters here it's not it's not that you have a relationship with with someone that or that you used to work in an insurance company and obviously i'm not the only one that thinks that that acquisition is not going to go well because a lot of richie bros shareholders are pushing against the acquisition going through uh majority shareholders they think that they are and they actually put some pretty good bull cases for copart in their in their letters because they were saying that iaa is such an

inferior asset to copart and that basically it's impossible to compete against copart right now and unless so if you're losing the focus because richie bros doesn't know how to run a business such as IAA. Yeah, that makes sense. And I don't, I think you're probably right. I don't think insurance companies are going to get rid of a really good service just to do a favor for someone who used to be in the industry. I guess you mentioned that revenue growth has been really strong over the last five years, especially for a business that's probably kind of, the narrative is that it's a boring industry. What do you think will be the big growth drivers moving forward?

Is it kind of just more of the same or is there any other kind of opportunities that you see down the road? So I'd say there are two main growth drivers. One is international and the other one is the rise of technology in cars. So Copart started some years ago to tackle international geographies

and as the model is kind of new there it's running into some white space so that's that's one and that's obviously important because right now so copart copart's buyer base is international but most of the volume right now is being sourced from the u.s so when they start to source this volume closer to where the buyers are then that obviously has implications to for buyers and for Copart's margins. So I think that's one of the growth drivers. The other one is kind of a strange one because technology is at the same time a growth opportunity, but at the same time a risk for Copart. But I'm going to talk here about the growth opportunity and then we'll talk maybe about the risk. So as cars get more advanced, they get easier to total and thus they drive more volume

to Copart. So the rationale here is that if a car today has a minor bump with a car in front, that bump will, that accident, that minor accident is going to break several sensors and cameras, which are pretty expensive components to repair. And not only are the components more expensive to repair, but repair shops are getting increasingly consolidated. So they have more bargaining power against the insurance companies. And also they need higher skilled labor because the repairs are more techie, so to say, because you have more sensors, cameras. So the repair costs in labor are also going up. So then going back to the formula I talked about earlier, if repair costs increase, then that's going to make it easier

for the cars to end up total because the insurer is going to probably lose less money by paying pre-accident value and just totaling the car it's also true that more technology makes accidents less severe but copart doesn't rely on accident severity if when you have a minor bump then the repair costs are like three thousand or four thousand dollars so i think that's going to be a pretty large tailwind and management also says that they expect total loss ratio to climb up a lot uh as the fleet gets um as the fleet shifts to a more modern vehicle vehicle fleet okay that's quite interesting oh ryan you have sorry follow up there well i guess one of the and maybe this is a quick answer but one of the one of the big

ones driving cars right ryan are you going on yeah one of the big risks that people called out on Twitter and they said, you know, what happens in a world where full self-driving prohibits all accidents or reduces accident frequency? Do you think that's a risk at all? Well, I think it's obviously a risk. The question here is when does this risk come? And I think that's actually the difference between a bull and a bear on Copart. I think there's no doubt that Copart is a very high-quality company, but obviously it commands a high margin. And when a company commands a high margin, then the focus should shift to the terminal value and not what the company is going to do in the next five years.

So obviously, we're not going to have autonomous driving in 100% of the fleet in the next five years. But if the market sees any kind of risk, then the multiple might be cut in half, for example, because obviously it's a risk for a company. But in my opinion, there are several hurdles to autonomous driving. So the first is the technology. The technology is still not sold and it's continuously being delayed. I'm not going to say who is delaying it, but I think everyone knows um then once this is uh once the technology is solved then you also have a regulatory change to make because who is going to assume the blame of an accident is it going to be the company is it going to be the the individual and i think this is going to be harder than it

looks to to tackle especially because insurers are going to make sure that that they don't lose a lot of money with with the new regulation and then when both things are solved you have to replace the entire vehicle fleet in the u.s which right now is around 13 years old so that means that it will take around 13 years to replace the whole vehicle fleet at the current at the current replacement rate this of course assumes that everyone trusts autonomous driving which i don't think will happen to be honest i think when it's introduced a lot of people won't trust autonomous driving for like basically you are putting your life on the line when it's when it gets very very good then maybe we'll people will start to to trust it but the thing is that to make a significant

dent to co-parts volume to co-parts volumes you need to have a large majority of the fleet in autonomous like 10 is is not enough because obviously other cars can crash against the the autonomous cars so i think that's obviously as a copart shareholder i have a strong view on this and i think that in the next 20 years autonomous driving is not going to be a risk for copart so i i obviously invest i don't think i'm not trying to project project out 20 years but if i'm going to be invested in copart for say 10 years i need to look 20 years out because obviously there the ending multiple is going to take into account the next 10 years um so i i'd say that it's it's a risk but i think it's still very far away and in the meantime it's a tailwind

for copart because all of the pre-order um so you have uh adas and then you have autonomous driving So as you advance in ADAS, that's a tailwind for Copart. So if a car becomes a microchip or a semiconductor chip, because that's where we're going. Like you have a lot of sensors, you have a lot of infotainment in the car. If that happens, that's a tailwind. And then you can have a terminal risk in autonomous, which I think is very far away. Yeah, no, it's quite interesting that the bear case might be, well, this business is going to get destroyed in 25 years. That gives the company quite a bit of time to figure out

what their business model will be during that and the world can change a ton in that way. And then that kind of leads us into the next part here, which is management. Thoughts on the management team? What do you think of the co-CEO structure? It seems like you think they have built up a great culture here and I'm curious why you think so. So I think, obviously, I think management is great but i don't think this is only a perception so if you look at the operational gap that copart has created with iaa that's obviously been management so management has been great for the last years because if not they wouldn't they wouldn't have won against iaa um willis johnson the founder has a significant stake and he is still involved he's obviously not the ceo but he's

still on the board and so obviously that's great too because you could the best alignment of interest is when there's high insider ownership management undoubtedly thinks long term i mean when you listen to a copart earnings call you'll listen you'll listen to the word decades quite a bit i think that's not normal in corporate america to to listen to the word decade or 20 30 year periods because that's where copart is is is aiming at like for example when they have um the significant cash position and no debt it's not because the business model cannot have like cannot weather a bit of debt obviously copart could be more efficient with it with its capital structure but that's management saying that they want the company to survive for a long period

and i know that there's a lot of discussion around the efficient capital structure theory or whatever but yeah but a black swan doesn't care about your capital efficiency structure like yeah i mean yeah a black swan can wipe you out even if you think you're prepared for it like who would have thought who would have made a capital efficient structure like the perfect capital structure thinking that we would have a pandemic like nobody so obviously if you actually want to be protected against everything then you have a lot of cash and you don't have debt that's and that's what management has done in fact when they saw that interest rates were going to climb they retired 400 million in debt i think that they have they did that they

had and they incurred a prepayment penalty but they said that it was the best choice seeing that where interest rates were going so the the co-ceo structure i think it makes sense although i'm pretty sure that the co-CEO structure is mainly on paper because Jeff Liao is basically running the company and Jay Adair is more on the strategic side of things and on the international business. So I would say that most of the CEO tasks are falling on Jeff and not on Jay. And also there's a bit of criticism because jay adair may retire soon and many are criticizing this move because he is quite young but i mean he has been working for copart since he was 19 and he has created a lot of shareholder value so my take is that i think he deserves to retire whenever he wants

and actually his compensation structure is quite interesting because the company pays him one dollar in salary and then stock options but only if on the vesting date the stock is above a certain price above a certain price and the price i cannot remember exactly the numbers but they are quite aggressive so if the company does if the company stocks doesn't do well then he gets no stock options and the rationale behind this was that the board argue that it was basically impossible to compensate someone that has almost a 1 billion stake with a salary of say 10 million dollars and i agree here because the best alignment is to have a large stake and obviously if you have 1 billion in stock and you are getting paid 10 million in salary you're not going to do

to care much about the salary you care about the stock that can make you a lot of more money than your salary so i think management is is great and the best thing is probably the the long-term thinking and and also that they are very humble and i think that's very important for a company that is already leading the industry because complacency is the worst thing that can that can happen to you what do you think of the buyback program do i guess do you care about it much they're they're more periodic it looks like than kind of putting it on the back burner and just doing a certain amount every quarter do you prefer that um i actually do because when you see when i see periodic buybacks that just tells me that management is buying when they have to be buying

so not it's it's like that they are taking the responsibility for those buybacks if you see periodic buying then management can say yeah we buy every quarter so we didn't know like it's like put on on this on autonomous mode like i don't do anything and i just like hit the buy button every quarter but copart i think has been very aggressive twice with buybacks um and i think they won't do buybacks unless the the stock craters and i think this is also uh a positive because that means that you're somewhat protected from a stock drop so for example i'm going to put here another case texas instruments now has 20 billion approved for for buybacks so you know that if the stock goes down a lot management is going to turn the buybacks on because they remain

also profitable in doing the downturns so you you are kind of you don't need to buy the dip because management is going to buy the dip for you so i think that's that's um pretty pretty positive although management did say that they have the cash the cash position just in case in some in the future they will have to use that cash to to buy back stock or or to whatever but i prefer this to uh to a more software approach where the software company is just by a reporter yeah and somehow their shares outstanding still go up but that's a conversation for another day uh this is the class this is almost this is one of those classic uh as some people might call the compounder stocks where people looking for competitive managers people looking for high

quality love this company never sell and see why never sell team you know all that type of uh narrative around that. However, when you look at the stock, clearly it is at a high earnings multiple. So how do you balance that when kind of valuing a company like this? Is it one where you have to be very patient and say, look, there might not be buying opportunities. They might be few and far between, but this is one where you get a good buying opportunity and then you never sell. How do you kind of look at it? Yeah. So valuation is always a bit controversial topic i think in many cases when you see high um multiples valuation multiples in some cases they might be inflated because actually the company's competitive position

or the returns that uh the company is generating not they don't have a high probability but But there's a reasonable probability that they might be competed away in the future. Here, I think that we have to, I don't think right now the company is a screen buy, obviously. But we have to take into account that Copart is reinvesting a large chunk of its excess cash and is doing it at high returns. And those returns are quite insulated from competition from what we've discussed. like even when IAA and Copart were both with an equal market share the returns were were good so obviously you can look ahead and think that Copart 10 years from now will still be generating significant returns especially because it's not a it's not a company that AI can maybe impact

a lot so most likely they will they would benefit from ai more than more than um suffer an impact and then if you couple a large reinvestment rate with high returns and a long run long runway ahead then that's that's actually the essence of compounding right so you need you don't only need high returns and and a high reinvestment rate but also to be able to maintain that reinvestment rate in the future i think copart has all three also i think the multiple is a bit misleading because copart has also seen a lot of an impact from inflation from towing and labor so the earnings are a bit so revenue has been growing at a nice pace but earnings have not kept up due to this a bit margin compression but i don't doubt that margins can get to where they

were. So, but it's what I said before, when one is investing at such high multiple, the most important consideration is the one of terminal risk. Like, I don't think if you're investing a company that's 30 times earnings, you should care about what the company is going to do next year. Well, maybe the market is going to make the stock price drop if earnings are not good. But if the long term is intact then that's not going to be a real driver of your returns but if you invest at a company at 30 times earning and there's a terminal risk that appears and your multiple resets to 10 times or 15 times then over a 10 year period it's going to be quite hard to have good returns because basically you're getting your the multiple cut in half um so

So the difference between seeing Copart as a, okay, like right now, I wouldn't say it's a screaming buy. It was a screaming buy maybe a couple of months ago, just like mostly every company. I think Copart, the bottom in October was $50 and it's right now at $80. So that's a significant run. um but i think that if you if an investor wants to hold this company they need to have a very strong opinion on autonomous driving because if not it's going to be very difficult to hold this like at the minimum doubt of autonomous technology being solved then you're probably going to scared uh like you're gonna be you're gonna be probably sell the position

so that's what i think i think that if copart for the next 10 years continues to reinvest at the same rate and at the same returns which i think it can because it has they are very protected from competition then i think it's not as expensive as many as many people think but if terminal risk doesn't if terminal risk shows up then obviously the margin of safety is not very high so i think if you have a strong view on autonomous then you might be comfortable paying a premium and if you don't you're going to wait for a for a better opportunity which might come i mean there are people that have been waiting for copart for a lot of years and obviously the pandemic was a perfect scenario because there was no driving so copart dropped quite a bit but the company

doesn't typically drop that much even if there's like during the gfc i don't i don't remember how much it dropped but i think it dropped less than the indices and then it doesn't suffer very very large drawdowns so i know for example that in my conversation with francois roshan he told me that that he had been waiting for copart he missed copart and he had been waiting for a long time for copart but obviously it didn't get to to his buying point so so yeah that that that's my opinion it is i mean you mentioned it the the ability for them to reinvest at high rates is kind of i think reflective of the stock price for people that haven't ever seen copart stock it it's more than a hundred bagger all time uh i think the proof's kind of in the pudding there but um i

I guess, based off this conversation, I think most people can probably tell this is a pretty high-quality business. Obviously, there's the one kind of looming pie-in-the-sky risk, which is no accidents anymore, but it seems like that's not really happening because there's a lot of accidents every year. What would it take for this to be a bad investment? I guess, what's the pre-mortem here? so besides the fact that autonomous might arrive earlier than expected and and this is a

this is a a risk that copart has so you're you're betting against um well you're betting up more than against more slow but you're betting against uh more slow and then obviously that all the time that it gets to like the vehicles the vehicle fleet takes to get replaced that would be probably the main risk and then the other risk for me is complacency which i think is this is the risk for any company that's leading an industry when you are the leader then obviously the probability of falling complacent is much higher and if they fall complacent then maybe who knows IAA might take market share in the future right now it does it seems like impossible but you never know if management gets complacent. I think probably another risk would be co-part diversifying

or diversifying to other sectors, because I think there's plenty of opportunity to grow in the industry that they excel at. And there are obviously some adjacencies that make sense. So for example, this is interesting because IAA, if it gets acquired by Richie Bros, then Richie Bros is saying that they are diversifying to the salvage market, which I think it's very difficult for them to do. But at the same time, I think that Copart would be better diversifying, like the probability of Copart diversifying to the used machinery market and being successful is higher than someone going into their include into their terrain and management in the last earnings call they asked them obviously about

diversifying and and they said that they don't say no that they are exploring things but right now they they're not going to they're not going to do anything but when you have yards you have towing obviously the the business models are pretty similar the the probably the the most difficult part is that you have you you don't have insurance insurers as customers so you have to go to against another customer group but i think diversification would probably made make the the business worse because especially because it's there's no need to do it with the runway that you have right now in in your, in your core market. All right. Well, I think that's pretty much all the questions we have. Brett, do you have any other ones? It looks like you're shaking your head. So that is going

to do it. Um, I guess Leandro, our listeners are probably familiar with you already. And I have to say you are a listener favorite, uh, among the chit chat money regulars, but, uh, number one show the last year yeah so yeah yeah i like that one go check that out that now that that that's that's due to their stock price performance right now of course well we do get a little i mean nvidia is number two with uh with luke so yes the uh the we need to listen to our listeners yeah the the listeners are a bit of a momentum indicator but uh yeah all right um i guess for anyone that doesn't know you or they're unfamiliar where can they follow along with any of your work? Yeah. So on Twitter, it's at InvestQuotes

or on Seeking Alpha at Best Anchor Stocks. That is my investment research service. Awesome. All right. Well, that is going to do it. We want to remind listeners that Brett and I are not financial advisors. Anything we say or discuss here on Chit Chat Money is not formal advice or recommendation. We are, however, general partners at Arch Capital. So clients may have positions in This security is discussed in this podcast. Thank you all for listening. Thank you, Leandro, for coming on the show again. And we'll see you all next time.