OPENLANE has been on fire lately. In the past six months alone, the company’s stock price has rocketed 57.1%, reaching $28.35 per share. This was partly thanks to its solid quarterly results, and the run-up might have investors contemplating their next move.
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Why Do We Think OPENLANE Will Underperform?
We’re glad investors have benefited from the price increase, but we're sitting this one out for now. Here are three reasons why KAR doesn't excite us and a stock we'd rather own.
1. Revenue Spiraling Downwards
A company’s long-term performance is an indicator of its overall quality. Any business can experience short-term success, but top-performing ones enjoy sustained growth for years. OPENLANE struggled to consistently generate demand over the last five years as its sales dropped at a 5.3% annual rate. This wasn’t a great result and signals it’s a low quality business.
2. Previous Growth Initiatives Haven’t Impressed
Growth gives us insight into a company’s long-term potential, but how capital-efficient was that growth? A company’s ROIC explains this by showing how much operating profit it makes compared to the money it has raised (debt and equity).
OPENLANE historically did a mediocre job investing in profitable growth initiatives. Its five-year average ROIC was 2.6%, lower than the typical cost of capital (how much it costs to raise money) for business services companies.
3. High Debt Levels Increase Risk
As long-term investors, the risk we care about most is the permanent loss of capital, which can happen when a company goes bankrupt or raises money from a disadvantaged position. This is separate from short-term stock price volatility, something we are much less bothered by.
OPENLANE’s $1.78 billion of debt exceeds the $119.1 million of cash on its balance sheet. Furthermore, its 5× net-debt-to-EBITDA ratio (based on its EBITDA of $316.7 million over the last 12 months) shows the company is overleveraged.
At this level of debt, incremental borrowing becomes increasingly expensive and credit agencies could downgrade the company’s rating if profitability falls. OPENLANE could also be backed into a corner if the market turns unexpectedly – a situation we seek to avoid as investors in high-quality companies.
We hope OPENLANE can improve its balance sheet and remain cautious until it increases its profitability or pays down its debt.
Final Judgment
We see the value of companies helping their customers, but in the case of OPENLANE, we’re out. After the recent rally, the stock trades at 30.5× forward P/E (or $28.35 per share). This valuation tells us it’s a bit of a market darling with a lot of good news priced in - you can find more timely opportunities elsewhere. We’d suggest looking at a safe-and-steady industrials business benefiting from an upgrade cycle.
Stocks We Like More Than OPENLANE
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