Ever thought that junk cars could be a great business? With repair costs exceeding vehicles’ market value, insurers are declaring more smashed cars as total loss. Salvage auto auctioneers are reaping profits from these damaged cars. In this business, total losses are good! Let’s dive deeper.
Business Model: From Trash to Treasure
The business model of salvage auto auction companies is pretty simple. If the repair costs of a car exceed its market value, insurance agencies usually declare it as a total loss, pushing it to the salvage market. Insurance agencies have a vast collection of cars damaged by accidents or natural calamity. Insurers' goal is to liquidate the cars they gain possession of after settling claims of customers. Insurance companies usually sell the damaged cars to auction houses. These salvage auto auctioneers sell the vehicles primarily to licensed vehicle dismantlers, rebuilders, used vehicle dealers, exporters and the general public. These firms actually profit from damaged cars, wrecks and write offs. We can say, they ‘make the junk valuable!’
Various barriers to entry and competitive advantages work in favor of the noted names in this industry. These include firms like Copart Inc. CPRT, KAR Auctions Services Inc. KAR and Insurance Auto Auctions aka IAA, Inc. IAA.
To compete well in this industry, the firms need scale. Buyers will be attracted to the platforms that offer a wide selection and sellers want to list on the platform that will generate the highest sales prices. Hence, it becomes a bit tough for new players to enter. In addition, one needs to have healthy relationships with insurance agencies and IT integrations in place to succeed. Also, with the majority of the supply tied to a couple of dominant players, it’s difficult for the new entrants to make their mark in this business. All in all, it is an oligopolistic industry.
Factors Driving the Salvage Car Auction Industry
The ratio of total loss to the amount of damage claims has been rising amid increasing average age of vehicles and technologically advanced auto parts.
Per IHS Markit, the average age of passenger cars has hit a record of 11.8 years. With vehicles depreciating in value as they age, the chances of them being classified as total loss increase. There has been a substantial increase in total loss rates over the past 10 years. Many a time, repair costs of old vehicles exceed the market value. In that case, insurers find it more profitable to pay out the pre-accident value to the claimant and sell the car at a salvage auction. The odds of old vehicles being classified as total loss in the event of an accident are high and will remain so. Per IAA, U.S. average vehicle age increased 3.5% during the 2013-2019 time frame and the total loss percentage of total claims rose around 36% during the same period.
In addition to the aging vehicles, technologically-advanced auto parts are also proving to be a boon for the industry. A large number of cameras, radars and sensors installed in the front or rear of a car are most frequently impacted in an accident. Costs of replacing these parts are extremely high, prompting insurance agencies to declare the vehicles as total loss. Vehicle complexity is not just increasing collision repair cost but also labor and parts expenses. While there are plenty of repair shops that can fix minor issues, there are fewer stores that have the technological expertise to recalibrate the sensors. Additionally, shift to the usage of aluminum instead of steel is increasing the cost of certain components, which further increase repair costs.
Moreover, increase in miles driven results in more collisions, which positively impact the industry. Per IAA, number of vehicles in operation increased 12.4% between 2013 and 2019, and miles driven edged up 8.5% during the same time period. Number of fatalities and miles driven are positively correlated. Faster speeds of driving coupled with the continued impact of distractions from cell phones and texting are also resulting in rise of accidents and total loss frequency.
Rising average selling price and international expansion are also driving the industry. Many a time, the salvage cars are not majorly damaged but are put into auction houses after being declared as total loss by the insurance agencies due to high repair costs. As such, the average sales price of such vehicles is on the rise. Also, efforts for foreign expansion by the companies and a large pool of international bidders are supportive of the increasing average sales price.
How are Copart & Others Placed in the Industry?
Copart is the market leader of the salvage auto auction industry. The eBay EBAY of auto auctions holds promise on the back of high activity levels in the United States and expansion efforts in Canadian and European markets. The firm’s strategic buyouts and balance sheet strength are also positives. The firm currently carries a Zacks Rank #3 (Hold) and has an expected EPS growth rate of 13% for the next three-five years.You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
KAR Auctions’ accelerated digital transformation and cost-containment efforts in response to the COVID-19 pandemic bode well. In fact, the digital model has boosted bidding activity. This in turn is resulting in higher bids per vehicle and widening geographical reach, thereby increasing the liquidity of the auction. This Zacks Rank #3 firm has an expected EPS growth rate of 5.5% for the next three-five years.
With the rollout of its ‘Buyer Digital Transformation’ ahead of schedule in April 2020, IAA expects to generate improved margins over the next several years. Additionally, the firm has identified opportunities in pricing via towing optimization and branch operational efficiencies, which will further aid margins. The Zacks Rank #3 firm has an expected EPS growth rate of 7% for the next three-five years.
COVID-19 Impact on Salvage Auto Auctions
The coronavirus outbreak has certainly weighed on the business amid weak vehicle demand and falling consumer sentiment. In general, amid the lockdown measures and sluggish economy, many customers put off discretionary purchases. Further, with more people working from home, there has been a reduction in traffic congestion and the number of miles driven, resulting in fewer collisions.
However, with shelter-in-place orders gradually being lifted, buyer attendance, bidding activities and revenue per unit have been stabilizing since May. That said, concerns regarding second coronavirus wave are also looming large. So, a full-fledged recovery hinges on the containment of the coronavirus spread.
A Word of Caution
Can advanced technology raise a red flag in future? Well yes!
Advancement in technology is currently a driving factor for the salvage auto auction industry as high repair costs for superior parts are resulting in increasing total loss frequency by insurers. However, rising adoption of superior and sophisticated technologies may actually lead to fewer accidents in the future. As safety technology and driverless technology improve over the years, there might be a downward trend in the frequency of collisions.
And that’s when this particular tailwind might turn to be a headwind for the industry!
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