Carvana stock: winner, long-term growth trajectory intact (NYSE: CVNA)

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Carvana Co. (NYSE: CVNA) is the leading e-commerce platform for used car trading. In just 8 years, it is clearly a disruptor that has become the second largest company in the sector. Recently, the stock is under tremendous pressure given headwinds from the macro-environment and the company’s logistical challenges. The used car market is historically very volatile, and CVNA is no exception. Future uncertainty remains, but CVNA’s capacity for growth and culture of innovation are undeniable. I think this is very high quality management and the stock is already punished. Things can only get better for CVNA.

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Data by YCharts

The first quarter of 2022 was a difficult quarter

The results for the first quarter of 2022 were not great. Market expansion momentum is not bad with retail units sold totaling 105,000 (14% increase) and revenue reaching 3.5 billion (56% increase). Gross margin decreased 12% to $298 million and total gross margin per unit (GPU) fell from $4,537 to $2,833. During the fourth quarter of 2021, the company guided a 29% increase in units sold and a $4,000 GPU with an EBITA margin of around break-even. It is very clear that CVNA did not provide these results. If we look at the all-time high, this may be the worst quarter since the company has ever cut both sales and units sold quarter over quarter (see chart below ). The only good news I found was that customers with 700+ credit scores increased by 50%, indicating strong customer engagement with his platform.

history of revenues and units sold

history of revenues and units sold (CVNA presentation)

The explanation for the direction of the crisis this quarter is similar to that of other auto dealers in the industry. Omicron, interest rates, inflation, winter storms and the war in Ukraine have all negatively impacted its business, driving operational costs, the logistics network, funding allocation and customer demand , all gone in the wrong direction.

The good news is that CVNA still leads the industry in revenue growth as one of the most disruptive companies, as shown in the chart below.

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Data by YCharts

CVNA is more sensitive to industry headwinds

One thing I learned from this quarter is that pioneering companies like CVNA are often more susceptible to unexpected industry headwinds. As the business is expanding, management often focuses on building long-term business structures under normal market conditions. During extreme events such as Omicron, winter storms and the supply chain crisis, I don’t think CVNA did anything to respond as management stated on the conference call :

If we go back in time to the fourth quarter, we were up 57%. In the third quarter, we are up 74%. So we were clearly growing at higher rates and anticipating higher sales rates in the first quarter because we didn’t understand what would happen industry-wide with affordability, interest rates and consumer sentiment, all of which lowered overall volumes.

CNVA typically accelerates SG&A and CAPEX spending six months in advance to match expected growth. In the first quarter of 2022, it opened the 15th, 16th and 17th Inspection and Reconditioning Centers (CRI). However, these centers are not yet fully exploited. Unexpected industry disruption leads to overcapacity and increases unit cost. As a result, net loss margin increased by 10.8%, EBITDA margin loss increased by 10.2% and total general and administrative expenses as a percentage of revenue in the first quarter increased. by 3.1%. This overcapacity and cost inefficiencies were expected to improve based on comments made during the conference call:

Over the next few quarters, we expect to better align sales with spend levels through a combination of higher sales and spend efficiencies. We expect this to result in a significant sequential decrease in general and administrative expenses per retail unit sold and an improvement in EBITDA margin in the second quarter.

The long-term growth trajectory is still excellent and could even accelerate with the acquisition of ADESA

CVNA is known for its differentiated business model and unparalleled customer services by providing the best selection, speed and value. Data, people and logistical infrastructure were expensive to build. But once they’re done, the cost of incremental sales (especially SG&A) should be lower than traditional resellers because of all the CVNA automation built into their business. In fact, CVNA’s GPU is already superior to competitors like CarMax (KMX) and America’s Car-Mart (CRMT).

Also, CVNA scales very effectively (ignoring the recent abnormal trimester). The graph below shows that new cohorts can often gain market share faster. 5 of the 9 cohorts had positive EBITDA margins, the two oldest cohorts achieved EBITDA margins above 4%.

market penetration by coharts

market penetration by cohorts (CVNA presentations)

ADESA is the second largest wholesale used vehicle auction provider. With the acquisition of ADESA, CVNA will immediately have 56 sites (6.5 million square foot buildings on 4,000 acres), workforce and business relationships. This equates to 30 Carvana IRC sites and an annual refurbishment capacity of 2 million while continuing to operate the wholesale auction business. Considering that CNVA has only built 17 IRC sites in the past 10 years, the addition of ADESA is a huge increase in capacity, as noted in the Q1 letter:

we will eventually have refurbished frontline inventory within 50 miles of 58% of the US population and within 200 miles of 94%. This will have the benefit of reducing shipping distances, times and costs, accelerating us towards our long-term financial model. In fact, we estimate that the sales we make today to customers within 200 miles of the IRC where their car is stored cost us $750 less in COGS and SG&A than our average sale. Additionally, the addition of ADESA locations in the United States will make our network more resilient and robust to weather disruptions by having more routes connecting origin and destination.

Recent layoff

On May 10, 2022, CNVA announced a 12% layoff of 2,500 employees in the operating groups. Management commented:

We believe that these decisions, while extremely difficult, will allow Carvana to restore a better balance between its sales volumes and its workforce and will facilitate Carvana’s return to effective growth as part of its mission to change the way people buy and sell cars.

This is in line with the company’s goal to rapidly reduce SG&A expenses per retail unit sold in the short to medium term. It is very likely that the acquisition of ADESA significantly reduced CVNA’s need to spend a large amount of CAPX, as you can see from the statement:

Generate positive free cash flow through a combination of retail units, GPUs, SG&A spend efficiency, and capital spend management to achieve self-financing without requiring equity or venture capital. additional loan.

Valuation and risks

CVNA’s long-term objective is to achieve gross margins of 15-19% and an EBITDA margin of 8-13.5%. As an extremely data-savvy company, its business model should be in a position to make money, as the second quarter of 2021 has already posted a positive EBITDA of 106 million. I think CVNA definitely makes the car buying process easier and automated, which should help achieve higher margins than others. Given the speed of its past growth, CVNA is the clear winner of the online car buying market. Based on third-party online traffic data, CVNA’s website already has more visits, unique visitors and time spent than KMX. Its bounce rate of 43.36% is also lower than others.

If CVNA can maintain its momentum and reach 2 million cars sold in the next ten years, it must increase its units sold by 14% per year, which is not at all difficult to do. If the average sale price of cars is still 15,000 like today, a turnover of 30 billion (same as KMX today) is expected. Assuming a very low net income margin of 3.3%, CVNA could achieve a net income of 1 billion in ten years. This only gets CVNA at a PE of 6.8x at current market cap. As the industry 5-year PE average is 13x, CVNA would have to easily double its price just to match the PE multiple with its peers.

Conclusion

Overall, CVNA is a very high quality company. Auto consumers are tired of dealing with dealerships for a long time. They want to have the comfort and confidence to buy cars in good mechanical condition with a wide selection at good prices. CVNA earns customer’s trust for now. If he can continue to do so, it will be very difficult to lose his position in the market.

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