Copart: At Risk Of A Disappointing Quarter (NASDAQ:CPRT)

Thesis

I do like the long-term bullish story for Copart, Inc. (NASDAQ:CPRT), which was explained very well by Saguaro Capital. However, I cannot justify a buy currently due to my anticipation of the following headwinds continuing to affect Copart, Inc.:

1. Used car market pricing is expected to fall further
2. Non-retail used car volumes are de-growing faster
3. There is a risk of continued margin misses.

Used car market pricing is expected to fall further

The long-term used vehicle prices have increased by 1.9% CAGR over the 23 years covering January 1997 to March 2020. However, since March 2020 to January 2023, this index has increased by 14% CAGR, driven by a combination of more than $4 trillion liquidity-infusion and semiconductor shortages reducing the supply of new vehicles and thereby pushing the prices of available supply up.

The correction in these market shocks began in 2022, as the Manheim Used Vehicle Value Index fell 14.9% over last year. According to Cox Automotive analysts, who have real-time access to high-frequency market intelligence, market equilibrium is still not reached and this pricing correction is expected to continue in 2023 till at least H2 2023; their 2023 forecast stands at a further decline of 4.3% YoY.

More than 80% of Copart’s volume is from salvage buyers not regular consumers. However, the prices in the salvage market will still be directionally correlated to the broader used car market prices lest the arbitrageurs swoop in for their free lunch. Hence, the outlook here spells some further pressures for Copart’s top line.

Non-retail used car sales volumes are de-growing faster

In the latest Q1 FY23 earnings call for the quarter ended October 2022, management gave some bullish commentary on the volumes side of the equation:

A decline in wholesale auction values may cause reduction in our ASPs but would almost certainly coincide with offsetting volume increases as well.

– Gavin Renfrew, Interim Principal Financial Officer

However, a sharp 5.6% decline in the rolling 2-month non-retail used car sales volumes suggests that this may not be playing out as per management’s expectations yet:

I look at non-retail volumes here to have a better proxy of salvage market volumes.

Thus, the high-frequency data suggests that Copart may have some larger than expected volume headwinds in the Q2 FY23 quarter. This would be a key monitorable during the possible earnings results release later this week.

There is a risk of continued margin misses

Copart has consistently missed on margin expectations by an average of 254bps over the last 6 consecutive quarters. The common explanation given by management in each of these quarters was a hit on gross margins due to a margin-unfavorable mix shift towards increased purchased vehicles, which suffered from worse realizations. Overall, this has led to a meaningful 1081bps fall in gross margins:

I would ideally like to wait for the margin bleed here to stop and stabilize, as I prefer to buy companies when their operating metrics are on an improving trend.

Positioning

No doubt, Copart, Inc. is a solid business and quality company. However, I see too many pressures continuing to affect the company’s sales and profitability via falling prices, weak volumes and a worrying habit of margin misses. I will eagerly look for signs of better commentary in Copart, Inc.’s next earnings call (earnings release anticipated on February 16). Till then, I rate Copart, Inc. a “hold.”