Copart Gets Torn Apart

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Willis Johnson used to run a business called U-Pull-It. These self-service scrapyards, since sold to Schnitzer Steel (Nasdaq: SCHN), allowed buyers to pay an entrance fee and pull parts off totaled cars. Johnson's multibillion-dollar baby, Copart (Nasdaq: CPRT), experienced a pick 'n' pull of its own after releasing fiscal second-quarter results late last week.

I've often championed scrap metal players, particularly Metal Management (NYSE: MM), but the auto salvage business is new to me. Copart essentially acts as a middleman between those in possession of salvage vehicles -- primarily insurers like Allstate (NYSE: ALL) and State Farm -- and eager buyers. Slowly, the company is diversifying away from insurers by signing deals with folks such as Harley-Davidson (NYSE: HOG), but insurers still provide more than 80% of the vehicles.

Because Copart's Internet auctions have broken down old regional boundaries, fully 28% of North American sales volume went to overseas buyers this past quarter. With the dollar's slide, our totaled cars look like a total bargain. Overall, the domestic business performed wonderfully, with high single-digit same-store sales fueled by volumes that went vroom-vroom.

I should mention that Copart's virtual bidding platform, VB2, was recently awarded a U.S. patent, which reinforces its already significant economic moat. When it comes to auction businesses, the network effect is king.

Speaking of that network, Copart is making a big push into the U.K., with 15 yards now under its belt. This is the piece of the business that's messing up analysts' spreadsheet models.

In the early months of operating abroad, Copart dialed way back on potential auction volume in order to get everyone up to speed on VB2. High fixed costs rendered the U.K. side's gross margin so thin it was translucent. Also hurting margins is the country's general adherence to a purchase model that requires Copart to act as principal rather than nimble intermediary. Buying these vehicles and reselling them isn't nearly as profitable.

Fortunately, these sources of margin pressure are temporary. The former issue will resolve itself right quick, although it's anyone's guess how long it will take the U.K. market to see the superiority of the "remarketing" model. Copart, as management so often emphasizes, is investing for the long term. Whenever it gains the trust of suppliers abroad, just as it has done over the decades here at home, the company will begin printing pounds just as it gushes greenbacks here at home.