Analyst: Carvana's Success Shows Used Car Market Ready For Disruption, Sees 35% Upside

Analysts at BMO Capital Markets initiated coverage of Carvana Co CVNA with an Outperform rating and $15 price target as the company is well positioned to benefit from the upcoming e-commerce disruption within the used car industry.

Carvana, the operator of an online marketplace for consumers to buy used cars, saw its shares move notably lower on its first day of trading in late April. The company priced its IPO at $15 and opened for the first time at $13.50 only to close at $11.10 on its first day.

According to BMO's Daniel Salmon, the U.S. used car market was valued at around $740 billion in 2016, which implies there is plenty of space for many players. Specifically, the largest player in the used car market, CarMax, Inc KMX, has just an approximate 1.7-percent market share and the top 100 companies combine for just 7 percent.

This plays favorably for Carvana as it is better suited to enter new markets at a faster pace than its peers. In fact, Carvana offers a "hassle-free alternative" versus the offline used car players through a differentiated shopping experience highlighted by free delivery of a purchased vehicle as soon as the next day.

Longer-Term Path To Profitability

Salmon estimated that Carvana will continue operating with a negative profit and negative cash flow since it is active in expanding into new markets. It won't be until 2018 when the company reaches a positive EBITDA, and it will take two more years until the company posts notable metrics.

The analyst is forecasting a 14.3 percent gross margin rate in 2020 and 6.7 percent EBITDA margins at the same time versus 5.3 percent and negative 23.2 percent in 2016, respectively.

Finally, the analyst's $15 price target implies an 8.5x multiple on his 2019E EV/EBITDA estimates and 3.3x 2019E EV/gross profit which is a discount to the used car dealer group that trades at 11.2x EV/EBITDA and 6.3x EV/EBITDA. Salmon believes Carvana deserves a premium valuation given expectations for a higher growth rate.

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Auto Industry Shifting From New To Used? CarMax Consistently Outperforms During Car Stock Weakness _______ Image Credit: By Carvana (Own work) [CC BY-SA 4.0 (http://creativecommons.org/licenses/by-sa/4.0)], via Wikimedia Commons