Global Compounders Portfolio: N.I.M.B.Y. Investing! – Turning Waste into Wealth

Permissible Accredited Investors* can now invests in GCP Strategy with minimum ticket size USD 25,000.

*Accredited Investors shall qualify eligible criteria as defined under IFSCA-IF-10PR/1/2023-Capital Markets dated January 25, 2024. 

For non-accredited investors, Investment in Marcellus’ GCP is through Separately Managed Accounts (i.e., SMAs, just like a PMS) via GIFT City (regulated by IFSCA) with a minimum investment amount of USD 150,000.
Latest regulatory changes pertaining to Global Investment:

These recent changes, which simplify and align long-term capital gains tax with domestic equities and allow resident Indians to open foreign bank accounts in GIFT City, significantly reduce friction.

For substantial wealth creation, ‘sexy’ is not necessarily the only way to go!

“I’m always on the lookout for great companies in lousy industries. A great industry that’s growing fast, such as computers or medical technology, attracts too much attention and too many competitors.” – Peter Lynch, Beating the Street

For as long as one can remember, humans have been attracted to people and things that promise to change the world radically, and for good reason. Inventions such as the electric bulb/telephone in the 19^th century, internet/semiconductors in the 20^th century & e-commerce/electric cars in 21^st century have played a disproportionate role in the betterment of human civilization – making the inventors and businessmen like Thomas Edison, Jeff Bezos & Elon Musk extremely wealthy in the process.

Meanwhile the stakeholders in the companies catering to these innovations have not fared too shabbily either. The business (& stock market) performance of technological giants like Amazon, Apple, Alphabet and more recently Nvidia has made many stakeholders – employees/vendors/shareholders – very rich over last two decades.

However, this newsletter is NOT about such companies!

Rather, in this newsletter, we discuss the kind of companies that get overlooked amidst the widespread fascination (and even euphoria!) that takes hold when an invention becomes successful and starts gaining scale. The current rhetoric around Artificial Intelligence being one such possible example. In general, and especially during such phases, the market tends to overlook the not so sexy parts of economy – howsoever important and wealth accretive they might be!

Such businesses may not have the exponential growth curve of technological/innovation led companies but just by virtue of their ‘utility’ nature have business longevity and higher earnings predictability on their side. In our Aug’23 newsletter, we covered how such firms create substantial wealth whilst staying under the radar through astute capital allocation.

The performance of one of such firm discussed in that newsletter – AutoZone (aftermarket auto parts retailer & distributor) – and its peer O’Reilly vis-à-vis the S&P 500 index over last 10 years speaks for itself (this is the time when market’s major focus has been on the Magnificent 7!). While most investors would be happy with 2-3% points alpha over benchmark index over a ten-year period, these companies have outperformed S&P500 index by 6-9% over a decade!

To watch out webinar on NIMBY investing, click here

In this newsletter, we dive into Copart, that some might call rather ‘unattractive’ sector. However, as the example of two auto parts retailers above has shown, unattractive does not mean ‘un-investable’!

Copart – using second hand vehicles to generate first class shareholder value!

“Whatever made it [junkyard] look nice, we did. That way, when people walked in, it was like they were walking into a real retail store. It made it more personal. They could shop. I know that sounds crazy – shopping at a wrecking yard. But no matter what you are buying, you want it to be a good experience, and you want to find what you want easily. Up until then, people just thought of a wrecking yard as a bunch of wrecked cars in a field that you had to wander through to find what you wanted”- Willis Johnson, ‘Junk to Gold: From Salvage to the World’s Largest Online Auto Auction’

Copart literally started its business dealing with ‘junk’. Willis Johnson – the founder of Copart grew up in his father’s vehicle dismantling yard (or a junkyard) in the 1970s, essentially selling torn down car parts. Willis, however, wanted to improve the business and one of the places he took an inspiration from was a grocery store he had worked at. He especially liked the nice organization of the SKUs in retail stores which led to better customer experience.

And so, even in the ‘junkyard’, he would paint the floors white every single year and organize the rows very cleanly, organize the parts and clean them for people. Over time he realized one of the ways to increase volumes was to specialize in a particular brand (rather than offering everything under the sun) and in doing so become the go to guy for that car brand’s aftermarket parts. The volumes increased from $3500 a month to $3500 a day as a result of this specialization.

Further, in a stark example of Willis’ vision being ahead of the time, he understood the importance of volume and turnover (much like in retail) and instead of relying on fax machine to send intimations to prospective buyers to garner bids for the parts in Copart’s inventory, he invested $100,000 – a substantial amount 50 years ago – in a computer system. This allowed him to not only track the inventory much more efficiently but also build the early iteration of virtual bidding system (currently at the firm is using Virtual Bidding 3 or VB3).

Another important way in which Copart’s management differentiated themselves is by thinking decades out and not the next quarter or two was through their real estate strategy (one can see parallels with best-in-class grocery retailers like Costco here). Copart owns a ton of land – essentially a junkyard. While analysts have voiced their frustration against such ‘capital heavy’ strategy, Copart decision safeguarded them against both inflation related rental costs (the effects of which were visible post Covid) as well as having spare capacity ready whenever there was an event like hurricane that led to a large influx of towed vehicles in need of a junkyard.

From a vehicle dismantler to a highly moated vehicle auctioneer

Copart of today is essentially a two-sided network that acts as an intermediary between buyers and sellers of salvaged cars by providing an online platform for auctions. The sellers are insurance companies, banks, rental fleet operators, and dealers, while the buyers are dismantlers, rebuilders, used car dealers, and licensed repairers. Copart has customers from all over the world, including North America, Europe, Africa, the Middle East, and Asia. However, the US remains its primary market with 82% revenue share as of 2023.

The company today sells two types of vehicles – salvaged cars (80% of revenue) and used cars (20% of revenue). In the US salvaged car market, which is essentially a duopoly, Copart is the dominant player with ~65% market share much ahead of #2 player IAA which has ~30% market share. In international markets Copart competes with local/regional players. In the US used cars market Copart faces competition from established players like ADESA, Manheim, and ACV Auctions.

Before getting into the nitty gritty of how Copart makes money, lets first understand a couple of key terms critical to this industry – salvaged vehicles and total loss ratio.

Salvaged vehicles are those vehicles which have been involved in an accident and the cost to repair the vehicle is more than its pre-accident value. In such cases insurance companies prefer not to pay for repair but rather declare the vehicle as ‘total loss’ and pay their customer an amount based on pre-accident value.

After paying such claims, insurance company prefers selling the damaged car for maximum value possible (to minimize its losses). This is where Copart comes in and provides an online auction platform to sell these damaged vehicles to prospective buyers. The buyers could be repairers, rebuilders or dismantlers who would either rebuild the vehicle for reuse or take out useful parts for reselling.

Total Loss Ratio is calculated as % of vehicle declared as total loss out of the vehicles which for which claims has been raised after accident. Total Loss Ratio in the US has increased from ~13% in 2005 to 20% 2023.

The aforementioned increase is a result of increasing cost of repair of cars – as cars have become more complex over the years (due to addition of various types of sensor and advanced features). Additionally labour cost to repair cars has also gone up as you need more skilled labor to undertake such repair. Higher cost of repair increases the chances of declaring the vehicle as total loss in case of an accident.

Under the used cars business, Copart sells cars from rental fleet operators, corporate fleet operators, used car dealers etc. It has expanded used vehicle offering to include powersports vehicles, and construction, agriculture and heavy equipment through acquisitions.

·    Percentage Incentive Program (PIP) where Copart sells vehicles and takes a percentage of the sales price as fee. Copart promotes PIP model as it aligns incentives with sellers.

·    Consignment Program (Fixed Fee) where Copart sells vehicles for a fixed fee. Ancillary costs such as towing, cleaning, and storing the vehicles are charged separately.

·    Purchase Program under which Copart buys vehicles directly from owners and then resells them through auctions. This model is primarily used in European markets like Germany and Spain.