«Craig Kennison, Analyst, Robert W. Baird & Co. Inc. Well good afternoon everyone. I think we will get started. Welcome to the KAR Auction Services ...»
Company Name: KAR Auction Services, Inc. (KAR)
Event: Baird’s 2014 Growth Stock Conference
Date: May 08, 2014
Craig Kennison, Analyst, Robert W. Baird & Co. Inc.
Well good afternoon everyone. I think we will get started. Welcome to the KAR Auction
Services Corporate Presentation. I’m Craig Kennison with Baird Research. KAR Auction
Services is a leading provider of auction services for used and salvaged cars and also
offers floorplan credit to dealers. We’re very pleased to have with us today Eric Loughmiller, the Chief Financial Officer and Executive Vice President; and Michael Eliason, the Vice President of Financial Planning and Analysis. We’re going to begin with a presentation from Eric and then we'll have plenty of time for a fireside chat.
At this time, Eric take it away.
Eric M. Loughmiller, Chief Financial Officer & Executive Vice President Thanks Craig. Can they hear me, yeah there we go. Just a quick introduction. They want to do this in fireside chat format, so I am not going to stand up. We operate in three major segments. We have a used car auction business called ADESA. We are one of two leaders in that business. We have about 24% market share. We operate on 67 sites in US, Canada, and Mexico. And the largest competitor is a company called Manheim owned by Cox Media which has 40% to 45%, they are not a public company, but 40% to 45% market share.
So we consider this a duopoly with the two of us combined having about 70% to 75% of the market in North America. We have a salvage auction business, which sells primarily total loss vehicles for the insurance industry. And the salvage business operates also in a duopoly. Us and a public company by the name of Copart, have probably about 80% of the market. We as an industry sell roughly 4 million units a year. We operate on 167 sites in the U.S. and Canada.
Interesting aspect, I will tell you a little more about the business as I go on. I won’t do it here. And AFC is a floorplan financing business which is focused on floor planning, independent used car dealers. In addition they do provide floorplan financing to some of the dealers that are buying cars at the salvage business. And we do a little bit of business in the RV, boats, recreational vehicles, power sports, a little bit there. But not very much.
It is substantially focused on the independent used-car dealer space.
Again, in this space it is a duopoly although this is a very unique niche market. We are focused on providing the floor planning to independent used car dealers so we exclude franchise dealers, but, again, Manheim has a captive finance company similar to this that is serving the independent used-car dealers like we are. And there the rest of the competition very fragmented whether it would be credit cards, local institutions, financial institutions, et cetera.
In terms of investment thesis, one of the key concepts since I have only got a few minutes to introduce the Company before Craig gets into questions is to really look at what is happening in the used car marketplace. That is our largest contributor of adjusted EBITDA, our major performance and our largest contributor of top-line revenue. That is the used car auction business. 45 million cars change hands every year in the United States and Canada. That is really the market we are focused on. Of that 45 million cars, you are going to see something in the neighborhood of 13 million will be consumer to consumer for the younger people. You go on craigslist, you identify someone, you call them that’s how you do it. But there is nobody in the middle of that transaction.
The remaining roughly 32 million vehicles are going to be somehow through a dealer connection or some professional connection. Of those, you are going to have at this point about 9 million units, the dealer is going to acquire at an auction run by ADESA or one of its competitors. The remaining roughly 23 million, they are sourcing direct purchases from other dealers, trade-ins from the consumer. They are going to source them in some manner where they get that used car without going through the auction network.
What is interesting about our business is we are in the big – I would say the early stages that has already begun, and the cyclical recovery in the used car marketplace. On this page, you can see we went through a period of call it recession, might have even been depression, where the volumes of cars that were being sold through our auction declined substantially from historical levels. This industry, the auction portion of this industry was selling between 9.2 million and 9.8 million cars for about roughly 15 consecutive years, very little volatility other than hundreds of thousands up and down and then 2008 occurred, late 2008 into 2009. It didn’t affect our volumes quite substantially early on because there is a three-year lag between when a commercial vehicle, predominantly an off lease vehicle, is returned and been processed through auction. Because that is a major source of the commercial vehicles.
There is also going to be a lag between the time someone buys a car and when it gets repossessed if they miss the payment. Often that will be 6 to 18 months after the initial purchase. So we didn’t see the real impact of what happened in the second half of 2008 until we got into 2010 and most substantially 2011 and 2012 as you see here. But beginning in 2013, we are seeing a recovery in our industry volumes and really this is predictable. We have good insight into this. It is heavily driven by the commercial vehicles. We have more cars coming off lease.
We have more new-car sales which are going to generate to the extent that they go to the subprime buyer in particular, or more repossessions. And then the dealer consignment, which makes up half the industry, is really going to be highly correlated to the trade-in of vehicles as they are buying new cars. And we all know that the new car sales have been increasing quite substantially over the last couple of years. So that is good for dealer consignment business. I am watching my time, Craig.
One of the moves we made in 2011 which has given us, in my opinion an advantage in the market, serving the marketplaces, we have acquired company called OPENLANE and integrated our technology with their technology. And we now are the primary supplier of the private-label closed sales platforms for the OEMs and their captive finance companies. General Motors operates – has operated through Smart Auction, which is owned by Allied Bank. So General Motors have their own solution. There is one foreign manufacturer that uses our primary competitor and there are two luxury brands that actually communicate directly with their dealership network for the closed sales and use the auctions behind it. All other brands, so there are roughly 33 or 34 brands in North America, 30 of those brands utilize ADESA for private-label closed sales. And this market is predominantly going to be the off-lease vehicles sold directly to the franchised dealer at end of lease.
In Canada, we operate the sites for every manufacturer. No exclusions, general Motors included. In the U.S., Smart Auction operates for them. So in Canada we actually have all of the manufacturers. The funnel we’re showing here is why we are confident of our performance in this marketplace. Because as the off-lease cars are returned in much higher numbers over the – in the current year over the prior year and for the next several years it's an increasing number, because those leases have already been written and their termination date is already determined. We get a chance for five to seven days to sell exclusively on our platform with no competition.
First, we must offer 2 to 3 days to the franchise dealers. If it does not sell to the franchised dealers, it then is offered to our entire buyer base, independent, other dealers of other brands. They have a chance to buy it. After five to seven days, the grounding dealer insist that that car be taken off of their lot because they had the choice early on to buy that car at residual value, contract value. So now it moves to physical auction. The reason this is exciting for us is we get 100% of those vehicles to sell. When it gets down to the physical auction, our share of the off-lease cars is roughly one out of every three comes to an ADESA site. Two out of every three go to a competitor. So you can see the tremendous advantage we have by having what we call the top of the funnel.
This is a major topic when I discussed this with investors who have followed us for a while. Craig asks a lot of questions about it. What is the impact? The major issue our industry is facing is there, has there been a secular change where the cars are not going to make it to the bottom? And the reason being my revenue per transaction at the top of this funnel is significantly less than what I generate at the physical auction. And you can see that on here. On the auction fee side you are looking at the very top of the funnel, something roughly$100. It goes up when you get to the online only open to three times what it is on the private-label close. And my transaction gets to a much higher number nearing $400 in many cases at physical auction. And at physical auction on that same car, I can do anywhere from $600 to $800 in ancillary services that are not in the auction fee revenue. So a much higher revenue opportunity if it gets to physical auction. This is receiving a lot of attention from investors.
Real quick, let me conclude by telling you just a couple of facts. The salvage business, values remain quite strong. There is a real demand for this because the only way they are going to afford to fix your fender bender if you have an insurance claim is using aftermarket recycled parts. Otherwise, it becomes too expensive for the client. So there is a heavy emphasis and you can see and many of you may follow the company LKQ. They talk about this all the time. About 40% of parts used in the collision repair industry right now are aftermarket recycled parts. So that’s a way to keep costs down.
We have plenty of demand for whatever supply comes out of this. An interesting statistic I share with investors is out of every insurance claim received, one out of seven results in a total loss. What that means is that one car must supply the parts to repair six others if the claim results in a repair. That's, as I say, a pretty good ratio for the economics of our salvage business. And we sell millions of cars – and 4 million a year are coming out of the salvage industry, which tells you how many cars are being repaired. In rough numbers, that would be somewhere in the neighborhood of 25 million a year. Now you get into again is the part available on time.
There are a lot of manufactured parts. Very interestingly, the lowest cost part for that repair and the highest margin for both the collision repair shop and the provider of the part is the aftermarket recycled part. The manufactured part is more expensive and has less margin for every player in the supply chain to get it into that vehicle. So that is why there is such an attraction to this marketplace. And on the floor plan lending business, the average loan is less than 60 days in duration from inception to payoff.
The maximum term is in the 90 to 120 days, they can’t extent beyond that and each loan is per car. There is a – we retain the title as collateral. While we give them a credit limit the loan is not a revolver. When they sell that car they have 24 to 48 hours to repay the loan. If they extend the loan, they must pay down principal; pay additional fees to extend it. It is car by car. It is not a revolving line of credit. And this is a great business and it has been a top-performing business. And we are actually have been for the last several years 99% or more current on the entire portfolio, which currently is over $1 billion in size.
And it has been over 19 and that means over 99% of loans are not even do, they have not even reached the maturity before they are paid. So that is a fantastic business. So Craig, I give you 16 minutes and 31 seconds to ask questions.
Craig Kennison, Analyst, Robert W. Baird & Co. Inc.
Well done. So we do have a moment in time for our Q&A if you have questions. Feel free to raise your hand and ask it. If you'd prefer to send it to this device, I can read it for you. And I will kick it off with a high-level question on technology. Over the course of the last decade we have seen the Internet come in and play a huge role in this space. What is it doing for you today and what are some of your investments you are making to make technology a part of the future?
Eric M. Loughmiller, Chief Financial Officer & Executive Vice President Well, the great part of technology is it gives access to a broader buyer base and when you are dealing in an open market like we create a market for the buyers and sellers to transact. We do not take principal risk on the vehicles. We don't participate in the value of that vehicle. We charge a fee for getting the buyer and seller together. And with the Internet, and the ability, we can increase the liquidity in the marketplace and all of you are investors, you know what that means.
More liquidity allows us to have a better pricing based on supply and demand equations.
So providing greater liquidity is high – providing higher returns to the consignors, providing more opportunities for the buyers. A buyer sitting in Chicago can be buying today in our Indianapolis, Kansas City, Cincinnati auctions, can be buying online from cars that are in any city where it is reasonable to transport the vehicle. They have a greater opportunity to choose what inventory will best meet the need of their retail consumer. The consignor loves it because I am expanding, if you go 20 years, it is whatever – whatever dealers could get to the site and buy the car that day. I have a lot more discovery that can occur, a lot more interaction.
We are investing over half of our CapEx per year which I didn't cover those details because of the short time, but last year we spend about $97 million, we have provided guidance in our last earnings call that this year is estimated to be $015 million, over half of that capital expenditure is into technology because the technology is the differentiator in the marketplace, it’s how we bring them together. We’re very focused on mobility.