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Cars, Losses, and Prospects: How Carvana’s Business Works

Carvana (NYSE: CVNA) is a site for buying and selling cars. The company has no P/E, it’s unprofitable. But it seems to be promising.

What they make money on

It is an online marketplace for buying and selling used cars. In essence, it is an online car dealer where the customer can buy, sell or exchange a car and then pick it up at one of the delivery centers or have it delivered.

According to the company’s annual report, its revenue is divided into the following segments:

  1. Sales of used cars to retail customers.
  2. Wholesale sales. This segment sells cars that have not passed quality control for sale to retail customers.
  3. Other. This is the sale of various financial products of the company’s partners such as insurance, service contracts, etc.

There is no information in the report about operations outside the U.S., so we will assume that the company does not operate anywhere but in America.

The company’s financial results by segment in thousands of dollars and units

201920182017
Revenue: used cars3 420 6011 785 045796 915
Revenue: wholesale267 58673 58428 514
Other revenue251 70996 83833 441
Total revenue3 939 8961 955 467858 870
Gross profit: used cars237 85594 31932 806
Gross profit: wholesale sales16 85055521845
Other income251 70996 83833 440
Total gross profit506 414196 70968 091
Number of markets at the beginning of the period854421
Number of new markets614123
Number of markets at the end of the period1468544
Used machinery for sale177 54994 10844 252
Wholesale Sales39 89515 1256509
Average unit price of a used car19 26618 96818 009
Average unit price in wholesale sales670748654381
Gross profit from the sale of the unit: used cars13401002741
Gross profit per unit in wholesale sales422367283
Other gross profit14181029756
Total gross profit per unit285220901539

Difference in the company’s financial results by segment as a percentage compared to the previous period

2018—20192017—2018
Revenues: used cars91,6%124,0%
Revenue: wholesale253,6%158,1%
Other revenue159,9%189,6%
Total revenue101,5%127,7%
Gross profit: used cars152,2%187,5%
Gross profit: wholesale sales203,5%200,9%
Other income159,9%186,6%
Total gross profit157,4%188,9%
Number of markets at the beginning of the period93,2%109,5%
Number of new markets48,8%78,3%
Number of markets at the end of the period71,8%93,2%
Used machinery for sale88,7%112,7%
Wholesale Sales163,8%132,4%
Average unit price of a used car1,6%5,3%
Average unit price in wholesale sales37,9%11,0%
Gross profit from the sale of a unit of used cars33,7%35,2%
Gross profit per unit in wholesale sales15,0%29,7%
Other gross profit37,8%36,1%
Total gross profit per unit36,5%35,8%
Source: Annual Report, pp. 59 (62)

Revenue and profit for the last 12 months in billions of dollars, bottom line margin as a percentage of revenue. Source: Macrotrends

Promising and something to look at

The company’s core strengths are about the same as CarGurus’: the U.S. car dealership market is low on digitalization and monstrously competitive, which leads to falling margins.

The noticeable disruption in the traditional way dealerships operate due to the pandemic may lead management to think about serious staff reductions and moving a significant portion of operations online. Moreover, there are a lot of employees in dealerships, and in the current circumstances not all of them are needed if the sales process is shifted online.

But potential consumers have an interest in online sales, and a very serious one at that. Together, all of these trends are good for Carvana: the low-base effect – only about 1% of U.S. auto sales are made online – contributes to the company’s natural sales growth. Maybe even some of the big car dealers will make a deal with Carvana to use the company’s site.

The used car market in the United States

Number of dealers in the used car marketMore than 43,000
Share of the largest dealer1,8%
Cumulative share of the largest 100 dealers8,6%

Source: Company presentation, slide 6

Number of employees at U.S. auto dealerships

Number of employees, million peopleAverage number of employees per company, people
20130,9959
20141,0463
20151,0866
20161,1269
20171,1370
20181,1468
20191,1470

Distribution of employees of car dealerships by occupation

Managers35,7%
Technical experts24,2%
Service23%
Sellers20,6%

Source: National Automobile Dealers Association report, p. 16 (17)

Attitudes toward buying a car online in the U.S. as the pandemic begins

April 2020June 2020November 2020
I wasn’t going to buy it before the pandemic and I’m not going to buy it now.39%40%40%
Wasn’t going to buy before the pandemic, but changed my mind29%30%26%
I was going to buy it before the pandemic, and I want to buy it now23%22%27%
Interest in buying online has increased9%7%8%
Going to buy a car online61%60%60%

Source: CarGurus study, p. 10

Relative attractiveness

This year, the company’s revenue has increased due to the growth in demand for online car sales. Given the digitalization trends in this area, we can expect growth to continue.

The company’s marketing department is adept at presenting numerous meaningless metrics that are designed to replace the lack of real successes: “in how many regions the company is now available to consumers,” “how the average price of machines purchased at the company website is growing,” even how many vending centers the company has and other information that in no way answers the question “When will your business start bringing in money?”

Financial result of the company by segments for three months by year and percentage difference

1 Jan – 30 Sep 20201 Jan – 30 Sep 2019Percentage difference
Revenues: used cars1 289 128931 06138,5%
Revenue: wholesale129 92592 43040,6%
Other revenue124 55671 40874,4%
Total revenue1 543 6091 094 85441,0%
Gross profit: used cars119 60760 56397,5%
Gross profit: wholesale sales17 1105572207,1%
Other income124 55671 40874,4%
Total gross profit261 273137 54390,0%
Number of markets at the beginning of the period26113790,5%
Number of new markets– —9−100%
Number of markets at the end of the period26114678,8%
Used machinery for sale64 41446 41338,8%
Wholesale Sales15 37511 69831,4%
Average unit price: used cars20 01320 059−0,2%
Average unit price: wholesale845079016,9%
Gross profit from the sale of a unit of used cars1857130542,3%
Gross profit per unit in wholesale sales1113476133,8%
Other gross profit1934153925,7%
Total gross profit per unit4056296336,9%

Financial result of the company by segments for the nine months by year and the difference in percentage

1 Jan – 30 Sep 20201 Jan – 30 Sep 2019Percentage difference
Revenues: used cars3 245 2092 470 63031,4%
Revenue: wholesale258 965188 47437,4%
Other revenue255 985177 20544,5%
Total revenue3 760 1592 836 30932,6%
Gross profit: used cars268 035171 06356,7%
Gross profit: wholesale sales25 88115 60065,9%
Other income255 985177 20544,5%
Total gross profit549 901363 86851,1%
Number of markets at the beginning of the period1468571,8%
Number of new markets1156188,5%
Number of markets at the end of the period26114678,8%
Used machinery for sale171 939127 17935,2%
Wholesale Sales33 40629 15514,6%
Average unit price: used cars18 87419 426−2,8%
Average unit price: wholesale7752646519,9%
Gross profit from the sale of the unit: used cars1559134515,9%
Gross profit per unit in wholesale sales77553544,9%
Other gross profit148913936,9%
Total gross profit per unit3198286111,8%

Source: Company Quarterly Report, pp. 45 (48)

Company growth metrics

Number of regional marketsNumber of units soldGross profit in dollars per unit
201596523206
20162118 7611023
20174444 2521539
20188594 1082090
2019146177 5492852
Q1 202016152 4272640
2nd quarter of 202026155 0982726
Q3 202026164 4144056

EBITDA margin as a percentage of revenue

2015−25,0%
2016−23,2%
2017−16,9%
2018−10,5%
2019−6,2%
Q1 2020−12,6%
2nd quarter of 2020−6,2%
Q3 20201,4%

Number of vending centers of the company

20151
20162
20177
201815
201923
Q1 202024
2nd quarter of 202024
Q3 202025

Source: Company presentation, slide 4

Race

One of the unpleasant features of online commerce is the enormous cost of logistics. About 73.2% of the U.S. population is in its service area. If you compare Carvana’s map of operations with that of its competitors from Vroom, it is clear that Carvana will continue to spend to expand its presence in different regions. To remain the leader and take market share as much as possible, it will take a lot of money, and that will get in the way of profitability.

But even without the expense of expansion, Carvana’s high-margin business seems to me almost impossible. Anything that involves online commerce has low margins and very often leads to heavy losses. Even Amazon doesn’t make most of its profits on online commerce. And practice shows that most companies do not even reach Amazon’s level: their delivery remains unprofitable for long, long years.

It is possible that the company will splurge on the purchase of Vroom, which will add debts of at least $6 billion to its $1.77 billion debt. There is a possibility that the purchase will be financed only in part by loans, and the rest will be obtained through the issuance of new shares. And it is not known how the market may react to it.

Given that the company is unprofitable and expensive, the shares could fall. On the other hand, in 2020, many companies issued additional shares and were not paid anything for it.

Delivery of Vroom vehicles by county in the United States. Source: Vroom presentation, slide 17 Company offices in different parts of the country by type: headquarters, operating areas, inspection center, and vending centers. Source: Company presentation, slide 16

Expensive and incomprehensible

In addition to the problems with the expansion of Carvana, there are difficulties with the adequate valuation of the company. It is clear that its market is promising, but it does not justify the capitalization of 50 billion dollars. The company could easily go down in price 5 times from the current price level. The worst thing is that at current prices, it is hard to find a buyer, because nobody wants to pay that much for a loss-making company. CarGurus is only worth a few billion and is already breaking even, so it has better sales prospects than Carvana. Even the loss-making Vroom, with a capitalization of about $5 billion, is much more likely to be bought.

Another problem: A significant share of car sales functions, according to users, should still come from live sales – see the table below. Therefore, the potential capacity of the online car sales market may be lower than many would like to think. In other words, in the future, the company’s revenue may grow worse than investors would like – this could lead to their disappointment and the collapse of quotations.

What steps in the ideal car-buying process Americans would like to see online in 2020

FebruaryAprilJuneNovember
Price negotiation25%65%63%61%
Auto Finance36%54%55%52%
Valuation of the machine when exchanging34%38%42%41%
Buying19%39%37%41%
Test Drive9%25%18%18%

Source: CarGurus study, p. 10

Summary

On the one hand, it is a promising sector, but on the other hand, it has a prohibitive, inadequate price. What will outweigh it in the end is unclear. But even now, one can invest in these stocks in the hope that Carvana’s quotes will continue to rise thanks to an influx of unscrupulous investors. However, there could be more stocks than unscrupulous investors – then there’s a very good chance that Carvana stock will fly off into the abyss during the market-wide correction.

So investing in Carvana now is like taking bitcoin. You never know what’s going to happen next: growth or decline. And bankruptcy for a loss-making company is always a more than likely prospect.

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