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Invest in This eBay Inc (EBAY) for Cars?

KAR Auction Services Inc (NYSE:KAR) is one of the largest domestic providers of vehicle auction services. It derived 54%, 36% and 10% of its fiscal 2012 revenues from whole car auctions, salvage car auctions and vehicle floor plan financing, respectively.

Of its three segments, the whole car auctions segment is the most cyclical, depending on used vehicle sales which in turn are driven by new vehicle sales. Despite this, KAR Auction Services Inc (NYSE:KAR)’s whole car auctions segment provides a large existing client base and strategic locations for cross-selling to customers in its salvage car auctions and vehicle floor plan financing segments.

KAR Auction Services Inc (NYSE:KAR)

KAR Auction Services Inc (NYSE:KAR)’s salvage car auctions segment, operated under Insurance Auto Auctions (IAA), combines the best of both worlds. It has competitive advantages that keep competitors at bay and positive demand drivers supporting near-term growth.

Competitive edge of KAR in the salvage car auctions space

Unlike auctions of paintings or antique vases, vehicles cannot be placed in any storeroom. Salvage car auction operators require a sufficient quantity of lots located across the country to facilitate the efficient hauling and holding of salvage cars. New entrants face an uphill challenge finding new areas to build holding lots.

Another advantage is that insurance companies are the key suppliers of KAR’s salvage car business. Most of these large national players prefer to do business with car auction companies of similar scale and reach across the country, like KAR.

Furthermore, IAA is the only salvage auction company in the country which offers buyers both physical and live online purchasing opportunities. IAA’s i-Bid LIVE platform, providing live auction internet bidding for salvage vehicles, allows potential buyer to see vehicle images and listen in to the auction event “live.”

Short-term growth driver: salvage car auctions

First of all, insurers are no longer the sole source supply of salvage cars. KAR is getting a bigger share of its salvage car auction business from car dealers, charities and consumers themselves. According to KAR’s 10-K, only 30% of vehicles de-registered annually are sold through salvage auctions, with insurers accounting for the majority of sales.

Secondly, the average ownership period of a car is now at an all-time high of 10.8 years as  of 2012, according to the results of a study by Experian Automotive.

Last but not least, recycled parts from salvage vehicles are gaining an increased acceptance within the collision repair industry. Alternative parts utilization levels have risen from about 25% to above 30% in the past decade, according to KAR’s most recent investor presentation.

Long-term growth driver: vehicle floor plan financing

KAR runs its vehicle floor plan financing segment under Automotive Finance Corporation (AFC) and works with independent used vehicle dealers. While AFC accounted only for 10% of KAR’s total revenues, it generated more than a fifth of KAR’s adjusted earnings before interest, taxes, depreciation or amortization (EBITDA). AFC delivers superior margins exceeding 60%, compared with margins in the 20%-30% range for KAR’s other two segments.

Although KAR grew its loan transaction by a four-year compound annual growth rate of 11% from 799,000 units in 2009 to 1.2 million units in 2012, loan transaction volume is small compared with about 14 million independent dealer used car sales in 2012. With a network of 11,000 dealers and more than 100 physical locations, KAR has the ability to grow AFC’s contribution through further market penetration.

KAR guided for full year fiscal 2013 earnings per share to increase by 24% year-on-year to $0.82 per share based on the lower end of its estimates.

Peer comparison

KAR’s peers include Copart, Inc. (NASDAQ:CPRT) and LKQ Corporation (NASDAQ:LKQ)

Unlike KAR, Copart, Inc. (NASDAQ:CPRT) is primarily focused on the salvage vehicle auction market.

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