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What happened to the new and used cars sitting on dealer lots in Houston after Hurricane Harvey?
It's estimated that as many as one million cars were damaged or destroyed, and tens of thousands of them sat at dealerships.
Companies such as Copart Inc. (NASDAQ:CPRT) came to the rescue, salvaging or selling damaged vehicles.
That's part of the reason Copart is considered an environmental, social and governance, or ESG, company. Vehicles that might have ended up in landfills were salvaged and recycled. Those it didn't salvage itself, it sold on through salvage auctions.
In its 10-K for 2019, the company wrote, "With respect to our environmental stewardship, we believe our business is a critical enabler for the global re-use and recycling of vehicles, parts, and raw materials. Many of the cars we process and remarket are subsequently restored to drivable condition, reducing the new vehicle manufacturing burden the world would otherwise face." Those that can't be restored are dismantled and sold for parts or returned to raw-material states.
Its main source of stock (inventory) are insurance companies that need to dispose of vehicles after they have been written off. In addition, the company sources cars from banks, fleet operators, dealers and individual owners.
Buyers include vehicle dismantlers, rebuilders, used vehicle dealers, exporters and, in some areas, the general public.
The business itself is divided into two sections:
Service revenues and sales (the salvage business): $1,755,694 in 2019 sales, making up roughly 84% of its revenue.
Vehicle sales (through its online sales facilities): $286,263, representing 16% of revenues.
Together, the two arms of Copart delivered more than $2 billion worth of revenue in 2019.
Management has made the business work for shareholders as well as the former owners of damaged cars and the environment. The following performance graph from its 10-K shows how Copart's total return has outperformed several Nasdaq indexes:
Focusing just on capital gains, we see the stock jumped from less than $10 in 2010 to more than $100 in February of this year, a 10-bagger for investors who bought and held throughout the period:
The company does not pay a dividend and has made only modest use of share repurchases, choosing instead to direct its free cash flow to expanding the business.
So there are compelling reasons why ESG investors would take an interest in this stock, but what about value investors?
Since Copart is also a Buffett-Munger Screener stock, we will analyze it using the four criteria the screener uses: predictability, a competitive advantage, little or no debt and undervalued or fairly valued status based on the PEG (or PEPG) ratio.
The predictability measure comes from a formula that weighs a company's ability to consistently grow its revenue and earnings per share.
Copart receives a 4.5 out of five-star rating, which means it is very predictable; in addition, it means the stock is likely to deliver double-digit returns and have a very small likelihood of being below the purchase price if held for at least 10 years.
This chart shows the growth of revenue and diluted earnings per share over the past decade:
Copart reported that it faces significant competition on both sides of its business. On the auto auctions side, American competitors include Insurance Auto Auctions Inc. and KAR Auction Services Inc. (KAR). On the salvage side, it faces the biggest American dismantler, LKQ Corp. (NASDAQ:LKQ) and others (American sales represent about 81% of its income).
Still, the company maintains strong margins, in the mid-30s, that have been relatively consistent, as shown in this chart:
Another perspective, provided by the Macpherson model, comes from reviewing a company's return on capital and return on tangible equity. Both should have a median score of at least 15% over the past 10 years. Neither has had a score of less than 15% over the past decade, confirming that Copart does have a competitive advantage, or moat.
Over the past five years, Copart has managed to reduce its long-term debt by a third, from $600 million to $400 million.
In part, that helps explain the company's strong showing in GuruFocus' financial strength rating:
Note that the interest coverage ratio is more than 40, meaning Copart generates enough operating income (Ebit) to cover the interest expense 40 times over.
In addition, potential shareholders would be comforted by knowing it generates a return on invested capital of 29.65%, almost four times as much as the weighted average cost of debt at 7.5%.
Based on a PEG ratio of 1.44, Copart is overvalued. This Peter Lynch measure sets 1.0 as its pivot, with anything less than that considered undervalued and anything over it as overvalued. At 1.44, the PEG ratio is below its 10-year median of 1.7.
The price-earnings ratio, at 31.1, is high, but down a bit from where it was before the market slumped earlier this year.
Similar news comes from the discounted cash flow calculator, which estimates Copart has a negative margin of safety of 17.7%
Whichever way we look at the data, Copart is somewhat overvalued, but is a bit of a bargain compared to its recent history.
Using the Buffett-Munger Screener analysis, we find Copart has strong predictability, a strong competitive advantage and a manageable amount of debt. What it does not have is undervaluation, though it is not too far removed from fair valuation.
What we haven't shown so far is its profitability rating by GuruFocus: A perfect 10 out of 10.
I wouldn't expect a company with this many strengths to appear on many lists of cheap stocks. The share price could be considered reasonable given its power to generate profits and its recent dip below its highs from earlier this year.
If you invest with an ESG perspective, this stock deserves a place on your shortlist because of the strengths observed and because of its environmental credentials.
Value investors might want to add it to their shortlists as well. It does not provide a margin of safety, but has a highly profitable business model. In addition, it has cash to grow the business since it does not pay a dividend and is quite conservative about buybacks.
Disclosure: I do not own shares in any companies named in this article and do not expect to buy any in the next 72 hours.
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This article first appeared on GuruFocus.