Why Kar Auction Services Is An Economic Reopening Stock

KAR Auction Services (KAR -0.53%) is in the business of auctioning used cars to dealerships and directly to consumers. The company suffered during the Covid-19-induced recession and has seen its stock price decline. However, as the post-pandemic economic recovery picks up, KAR Auction Services stands to benefit.

In this Motley Fool Live video from the Industry Focus podcast recorded on March 11, Motley Fool contributor Luis Sanchez and Industry Focus host Nick Sciple discuss KAR Auction Services, Copart, IAA, and the market for used cars.

Nick Sciple: One other company we did mention, maybe we can talk about briefly are KAR Auction Services, ticker KAR, and they are in a little bit different niche relative to what IAA and Copart are doing.

Luis Sanchez: For sure. So KAR Auction Services. You mentioned the ticker, KAR. They are in what's called whole car auction, so that's non-totaled cars. It's really just used car auctions. The way to think about where they sit is, they source inventory from all sorts of interesting channels. So when rental car fleets turn over, when rental cars want to replace their used cars with brand new cars, they'll take it to auction through KAR. Or when people who are leasing cars abandon their leases, assuming the cars are still in good condition, they'll offload to KAR. Or charity auctions, people who donate their old used cars to charities. Then what KAR really does is they're a B2B business. Basically, the people who are buying on the car auctions are primarily used car dealerships who will then sell to a retail channel. There's also some individual buyers who will also shop on KAR. But it's really a B2B business. I'd say there's really interesting differences though between the total car auction market and the whole car market. Namely, it's that this is a more competitive channel because there's just a lot more places to source used cars, right? eBay, Craigslist being one. Some used car dealerships will actually buy used cars from other dealerships, right? There's other B2B used car channels, it's not just the auction. You can do private brokerage or just direct. That's on the demand side. On the supply side, the inventory is less guaranteed. I think that's really the story of the last year with KAR is, they've really suffered from the shortage of used cars. So because there haven't been new cars to purchase, rental car fleets aren't getting rid of their existing fleet. Because the price of a used car has gone up so much, this is actually a really interesting situation where people who are sitting on leased cars, they're not abandoning the lease. They are actually buying the cars because the price of the buyout option is set at the beginning of the lease. So there's a little bit of an arbitrage now that used car prices have gone up so much. Yes, so KARS actually suffered and they've actually seen their revenue decline quite a bit in the last year as a result of these factors. They also did get squeezed, to the extent that KAR needs to buy inventory, they're going to have to pay the higher price for those used cars.

Nick Sciple: Absolutely. So they may be have been a little bit more victim of what has gone on over the past year, whereas you look at Copart reporting record numbers across the board in the most recent quarter, they've been a beneficiary in this way. Do you see KAR as being a potential reopening play? People are going to start traveling again, getting rental cars when they go to Hawaii and places like that. Do you see this as a business that could potentially benefit from a recovery?

Luis Sanchez: Absolutely. I think KAR, of all these three companies I've mentioned, I think KAR is probably going to benefit the most from a recovery. But what you would need to see for them to really benefit from a recovery is some kind of normalization of the value of used cars, the used car index. It's also interesting to think about whether Copart or IAA are reopening plays because that's actually really hard to know. The answer is yes or no. Because Copart and IAA have seen their volume of cars sold decline, but they've seen the value go up. So if we get into a situation where the volumes of used cars go up, but the prices of the used cars also remains higher elevated, then IAA and Copart can continue to benefit. But we could also see the opposite, like what happens if the value of used cars goes down? Well, that might become a headwind and that might potentially benefit KAR. KAR also, the way they make money is a little bit different from Copart and IAA, which is also worth mentioning. KAR makes about half of their money from, half of their revenue from auction proceeds. But the majority of KARS' earnings are actually from the ancillary services that they provide. More than a third of KARS' earnings are actually from financing. So they're really involved in helping people complete that purchase. That's actually really KARS' competitive advantage. They're basically financing these used car dealerships, they're financing the floors. In a lot of cases, that's the reason why used car dealerships are doing business with KAR because not only can they source the inventory, but they can finance it at a reasonable rate.

Nick Sciple: Absolutely. So the relationships, it sounds like in this business, is very different when you're talking about the customers that you're working with. Because those customers have different needs, different service is offered.