Carvana Might Be Beginning To Find Its Wings

With Quiver Quantitative’s recent institutional holdings data, we can see that many hedge funds and asset managers have increased their stake in Carvana CVNA. Firms such as Point72 Asset Management, Coatue Management, and Fidelity Investments have all added to their CVNA positions recently. Most notably, Fidelity Investments increased shares held by nearly 144% (as filed on 03/31), bringing their total CVNA holdings to 4,667,263 shares worth around $215 million dollars at current market prices. With this in mind, we took a closer look at some of the reasons why many investors may be bullish on Carvana.

Last week, Carvana experienced a significant surge in its shares, rising up to 40% due to the announcement of a beneficial debt restructuring agreement. This agreement is set to reduce the company's total debt by an impressive $1.2 billion dollars, eliminate over 83% of its 2025 and 2027 unsecured note maturities, and result in a substantial reduction of more than $430 million dollars in required cash interest expenses annually for the next two years. Alongside this positive development, Carvana also reported promising earnings results for the second quarter of fiscal year 2023, surpassing both revenue and earnings per share (EPS) estimates by a considerable margin. These positive earnings and the favorable debt restructuring agreement appear to have improved the market's perception of Carvana, which had faced challenges during the Covid-19 pandemic.

Carvana is the leading e-commerce platform for buying and selling used cars. Carvana is changing the used car marketplace by offering a wide selection of vehicles with transparent pricing and simple transactions. Through the use of technology and a convenient car buying / selling platform, Carvana gives car buyers and sellers a convenient alternative to the highly fractured used car dealership industry. Consumers can research and identify a vehicle, inspect it using Carvava’s patented 360-degree vehicle imaging technology, obtain financing and warranty coverage, purchase the vehicle, and schedule delivery or pick-up, all from a mobile device or desktop. Additionally, Carvana utilizes technology and proprietary algorithms to optimize their inventory pool and operate their own logistics network to deliver cars to customers. Their vertically-integrated e-commerce platform makes buying and selling cars easy, providing a sound alternative to the traditional used car dealership industry that has become increasingly more expensive, time consuming, and frustrating since the onset of the Covid-19 Pandemic.

The U.S. Automotive industry generated around $1.2 trillion dollars in sales in 2021, making up 23% of the U.S. retail economy. This makes it the largest consumer retail market in the United States. On top of this, the used car retail industry is highly fragmented. The largest dealer brand controls 2.3% of the U.S. market and the top 100 used car retailers make up around 11% of used car retail market share, combined.

According to the 2022 Cox Automotive Car Buyer Journey Study, only 58% of used car buyers were satisfied with their experience. This is because the traditional car retailing model is inefficient and operationally challenging. Customer acquisition is very expensive for traditional retailers, as they are largely confined to local advertising channels and have to drive foot traffic to their physical locations, which offer limited inventories and oftentimes, an undifferentiated service. Traditional retailers will continue to feel the pain as consumers change the way they buy cars. With e-commerce making up 14% of total U.S. retail sales in the first three quarters of 2022, consumers are becoming increasingly more comfortable and adept with making online purchases. This sentiment can be seen within the automotive / car retailing industry, with 64% of buyers preferring to experience more of the purchasing process online, compared to their last vehicle purchase, according to a 2021 study from Cox Automotive. Another study from Cox Automotive in 2022 found that the typical car buyer spends around 8 hours researching their prospective car purchase online, adding credence to the data point mentioned earlier that 64% of buyers preferred to experience more of the purchasing process online.

Carvana acknowledges that consumers want a wide selection of vehicles, fair valued vehicles, confidence in vehicle quality, control within the buying process, and a fast and simple buying process when it comes to purchasing a car. However, many traditional used car retailers are not able to meet these consumer needs. They often lack the scale, staging capacity, and local demand for a diverse inventory and fair valued cars, as they operate with high overhead costs that must be passed on to consumers. Additionally, on the point of lacking scale, many traditional used car retailers don’t have the scale and / or expertise to uniformly recondition their vehicles and ensure their mechanical soundness, leading to an increase in the chances that they sell a “lemon” (a car with a significant defect or malfunction), leading to poor consumer experiences. To make matters even worse, traditional auto dealerships have a long, multi-part transaction process that can take hours. A 2022 report from Cox Automotive found that the average car purchase at a traditional retailer takes three hours on average. Because of these issues within the traditional used car retailer transaction process, only 43% of American consumers view the automotive industry positively, according to a 2021 Gallup Poll. With poor consumer sentiment within the used car retail industry, Carvana is able to introduce itself into the market with solutions that make the process easier for consumers, making Carvana a strong option for used car buyers.

Carvana offers customers a national inventory pool of tens of thousands of quality used vehicles (although they have recently made strides in lowering their inventory to meet demand and focus on profitability) on their website, giving them superior inventory to traditional used car retail competitors. Their proprietary algorithms help them optimize inventory acquisition based on extensive customer behavior data, ensuring that they offer the best quality inventory in the used car retail industry. Most importantly, Carvana is able to provide customers with lower vehicle costs and increased value as their vertically integrated business model allows them to operate at a significantly lower variable cost structure compared to traditional used car retailers. Whereas traditional retailers have to pass on high operating costs to customers, Carvana is able to pass on cheaper costs and higher value to customers as they operate at a much larger scale, giving them a strong competitive advantage in terms of pricing. This is a particularly strong advantage given that consumers are becoming increasingly cost aware in this post-Covid inflationary environment.

Another competitive advantage to consider is their truly unique vertically integrated e-commerce platform, which offers a superior customer experience to competitors. Simply put, Carvana is able to sell cars cheaper than any other competitor with a customer experience that cannot be matched by other competitors. Carvana deeply understands what customers want, and through proprietary software and customer behavior data, they are able to consistently offer a car-buying experience that is enjoyable for customers. Positive customer interactions and transactions open up the opportunity for repeat customers and a strong referral network, allowing Carvana to continue to grow organically, capture additional market share, and gain a stronger foothold in the highly fractured used car retail industry.

Carvana already offers a best in class car buying experience for customers, however, they have ambitious plans to continue to grow and add value to customers. Notably, they have taken on the initiative to continually optimize their inventory selection, one of the largest contributors to sales. With the acquisition of ADSEA and 56 of their auction sites, 78% of the US population is within 100 miles of an IRC (inspection and reconditioning center) or auction site, meaning that distances between inventory pools are shortened, delivery times are reduced, and sales conversions increase. On the topic of increasing sales, Carvana also plans to continually invest into technology leadership and their mobile sales platform. Due to the complexity of automotive retail transactions, Carvana plans to invest into technological advances that further separates them from competitors and allows them to enhance the transaction process. Additionally, a 2022 Pew Research study found that 76% of U.S. adults say they make purchases using a mobile device, with a third claiming they make mobile purchases weekly. Carvana plans to increase mobile based sales by offering a best in class, innovative mobile experience to capture additional market share in this large and growing market. 

While Carvana’s business model, competitive advantages, and growth prospects look strong, it is important to consider quantitative metrics as well. Looking at Carvana’s income statement, we can see some stellar growth in revenues and gross profits since their IPO in 2017. In 2017, Carvana had total revenue of nearly $859 million dollars and gross profit of nearly $71 million dollars. Carvana now sports LTM (Last Twelve Month) revenue of nearly $11.8 billion dollars, representing a revenue CAGR of nearly 55% in those 6 years. Additionally, Carvana now sports gross profit of around $1.4 billion dollars, representing a CAGR of 64% in that same time frame. While their top-line growth has been stellar, their bottom-line has not, but that is to be expected from a growing company like Carvana. As a growing company, Carvana's focus on aggressive expansion and market penetration has resulted in increased operating expenses and significant investments in infrastructure, technology, and customer acquisition. These growth ventures temporarily affect a business’s bottom line, but with their recent debt restructuring deal, Carvana is nicely setting itself up for long-term profitability as it continues to mature and capture market share in the highly fractured used car market.

Additionally, looking at Carvana’s balance sheet, we can see that the company is doing better financially, however, there is still room for improvement. Carvana currently has around $541 million dollars of cash on hand, compared to long term debt of $6.27 billion dollars. While this isn’t ideal, it is a manageable long-term debt to cash ratio. To make the scenario a little better, Carvana has increased its cash holdings every year since 2019, while recently taking on initiatives to lower its long-term debt holdings. While they are currently operating at a fairly bloated debt level, they are taking initiatives to pay down debt and secure longer financial stability and runway. 

While Carvana battles with profitability, it seems that investors may be undervaluing the company’s revenue generation potential. As mentioned above, Carvana has been able to generate revenue handsomely, growing revenue at very high CAGRs (50%+) since their IPO in April of 2017. Carvana is currently trading at a 1.03x NTM EV / Revenues figure. With an increasing macroeconomic climate, it is safe to assume that a rebound in car purchases will help boost revenue growth, in addition to the growth initiatives touched on earlier. As car sales rebound and Carvana continues to increase revenues via investments into inventory optimization, technology leadership, and the customer experience, there is a good chance that Carvana will experience multiple expansion in regards to the NTM EV / Revenues ratio. If Carvana continues to expand and improve their financial health, it is likely that investors will be willing to pay more for the company’s future revenue.

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