Insurance Auto Auctions: A Great Company At A Fair Price

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About: IAA, Inc. (IAA), Includes: KAR
by: Stock Spin-off Investing
Summary

IAA is a very attractive business with near-term secular tailwinds.

In the very long term, the business will be negatively impacted by autonomous vehicles.

IAA trades at a premium valuation but would be a buy on a pullback.

Introduction

On June 28, 2018, KAR Auctions Services (KAR) spun off its insurance salvage auto business into a new public company called Insurance Auto Auctions (IAA).

Overview

IAA runs auctions for totaled (or very high-mileage) cars. The company holds 40% market share in the US market, while its closest competitor, Copart (CPRT), also holds ~40% market share. The auctioned vehicles are predominantly sold by insurance companies (~80%). Other sellers include auto-dealers, vehicle leasing companies and rental and fleet car companies.

Why would an insurance company want to sell a vehicle for scrap value? If it would cost an insurance company $15,000 to repair an insured vehicle to pre-accident value, but the vehicle would only be worth $12,000 after its repairs, then it makes more sense for the company to write a check to the insured party for $12,000 and sell the damaged car for scrap value.

Typical buyers include dismantlers, rebuilders, recyclers, and exporters who purchase salvage vehicles for scrap, replacement parts, or vehicle builds. IAA earns fees from both sellers and buyers of salvage vehicles.

The salvage auction business (IAA and CPRT) is appealing for a number of reasons.

Limited Cyclicality

Cars get totaled whether or not we are in a recession. The business isn’t reliant on people buying new cars and trading in their old cars, but more so on accidents occurring. While miles driven will likely decline (and could lead to fewer accidents) in a recessionary environment, we won’t see a dramatic fall-off.

As shown below, sales grew during the Great Financial Crisis.

(Source: KAR Spin-off Slide Deck)

Growing Car Parc

The United States Car Parc (registered vehicles) has grown from 249 million in 2013 to 276 million in 2016. Further, miles driven are increasing as well. This results in more accidents.

(Source: KAR Spin-off Slide Deck)

Meanwhile, the average age of vehicles in the U.S. has increased from ~11.4 years in 2013 to ~11.7 years in 2018. Older cars are more likely to be salvaged, as their repair costs represent a larger portion of pre-accident value.

(Source: KAR Spin-off Slide Deck)

Increasing Accident Frequency

From 2012 to 2015, the number of reported crashes in the United States grew by 12.1%. Over the same period, miles driven increased by 4%. These statistics indicate that the frequency of crashes is increasing. Contributing factors include an aging car parc and more distracted drivers (texting while driving, etc.).

Increased Total Loss Frequency

As shown in the chart below, total losses as a percentage of total claims has increased from 14.1% in 2013 to 19.2% in Q1 2019.

(Source: KAR Spin-off Slide Deck)

What is causing this trend? Increasing vehicle complexity as manufacturers utilize the latest technology to differentiate their cars. All the extra sensors, cameras and gadgets are expensive to fix once broken.

Autonomous Vehicles

While IAA has a number of near-term tailwinds, autonomous vehicles are a headwind in the long term. Accident rates are expected to decline significantly once autonomous vehicles become well-established, decreasing the number of totalled cars that can be auctioned.

Good Management

John Kett is the CEO of IAA. He was the CEO of IAA when it was a part of KAR Auction Services. He has an excellent track record. For instance, he tripled the number of corporate-owned auction facilities since assuming the CEO role in 2014.

Financials and Valuation

As shown below, IAA’s financial performance has been quite strong. Revenue has grown at a 10% CAGR over the past three years, while adjusted EBITDA has grown at a 17% CAGR.

(Source: KAR Spin-off Slide Deck)

(Source: KAR Spin-off Slide Deck)

In 2019, sell-side analysts expect IAA to generate $1.38 in EPS and $414 million in EBITDA. As such, the company is trading at 29.2x earnings and 16.0x EBITDA.

(Source: Stock Spin-off Investing and YCharts)

Copart, IAA’s closest peer, trades at 34x earnings and 22x forward EBITDA. As such, IAA looks cheap on a relative basis. Nonetheless, it is a little too pricey for me on an absolute basis, but I would be a buyer if it were to pull back significantly.

Another reason I’m not as interested in IAA is because it's a relatively large company with a $6.6 billion enterprise value. I closely track spin-offs, and have found that the best opportunities usually come from the smaller spin-offs.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.