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

	2019	2018	2017
Revenue: used cars	3 420 601	1 785 045	796 915
Revenue: wholesale	267 586	73 584	28 514
Other revenue	251 709	96 838	33 441
Total revenue	3 939 896	1 955 467	858 870
Gross profit: used cars	237 855	94 319	32 806
Gross profit: wholesale sales	16 850	5552	1845
Other income	251 709	96 838	33 440
Total gross profit	506 414	196 709	68 091
Number of markets at the beginning of the period	85	44	21
Number of new markets	61	41	23
Number of markets at the end of the period	146	85	44
Used machinery for sale	177 549	94 108	44 252
Wholesale Sales	39 895	15 125	6509
Average unit price of a used car	19 266	18 968	18 009
Average unit price in wholesale sales	6707	4865	4381
Gross profit from the sale of the unit: used cars	1340	1002	741
Gross profit per unit in wholesale sales	422	367	283
Other gross profit	1418	1029	756
Total gross profit per unit	2852	2090	1539

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

	2018—2019	2017—2018
Revenues: used cars	91,6%	124,0%
Revenue: wholesale	253,6%	158,1%
Other revenue	159,9%	189,6%
Total revenue	101,5%	127,7%
Gross profit: used cars	152,2%	187,5%
Gross profit: wholesale sales	203,5%	200,9%
Other income	159,9%	186,6%
Total gross profit	157,4%	188,9%
Number of markets at the beginning of the period	93,2%	109,5%
Number of new markets	48,8%	78,3%
Number of markets at the end of the period	71,8%	93,2%
Used machinery for sale	88,7%	112,7%
Wholesale Sales	163,8%	132,4%
Average unit price of a used car	1,6%	5,3%
Average unit price in wholesale sales	37,9%	11,0%
Gross profit from the sale of a unit of used cars	33,7%	35,2%
Gross profit per unit in wholesale sales	15,0%	29,7%
Other gross profit	37,8%	36,1%
Total gross profit per unit	36,5%	35,8%

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 market	More than 43,000
Share of the largest dealer	1,8%
Cumulative share of the largest 100 dealers	8,6%

Source: Company presentation, slide 6

Number of employees at U.S. auto dealerships

Distribution of employees of car dealerships by occupation

Managers	35,7%
Technical experts	24,2%
Service	23%
Sellers	20,6%

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

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

	April 2020	June 2020	November 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 mind	29%	30%	26%
I was going to buy it before the pandemic, and I want to buy it now	23%	22%	27%
Interest in buying online has increased	9%	7%	8%
Going to buy a car online	61%	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 2020	1 Jan – 30 Sep 2019	Percentage difference
Revenues: used cars	1 289 128	931 061	38,5%
Revenue: wholesale	129 925	92 430	40,6%
Other revenue	124 556	71 408	74,4%
Total revenue	1 543 609	1 094 854	41,0%
Gross profit: used cars	119 607	60 563	97,5%
Gross profit: wholesale sales	17 110	5572	207,1%
Other income	124 556	71 408	74,4%
Total gross profit	261 273	137 543	90,0%
Number of markets at the beginning of the period	261	137	90,5%
Number of new markets	– —	9	−100%
Number of markets at the end of the period	261	146	78,8%
Used machinery for sale	64 414	46 413	38,8%
Wholesale Sales	15 375	11 698	31,4%
Average unit price: used cars	20 013	20 059	−0,2%
Average unit price: wholesale	8450	7901	6,9%
Gross profit from the sale of a unit of used cars	1857	1305	42,3%
Gross profit per unit in wholesale sales	1113	476	133,8%
Other gross profit	1934	1539	25,7%
Total gross profit per unit	4056	2963	36,9%

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

	1 Jan – 30 Sep 2020	1 Jan – 30 Sep 2019	Percentage difference
Revenues: used cars	3 245 209	2 470 630	31,4%
Revenue: wholesale	258 965	188 474	37,4%
Other revenue	255 985	177 205	44,5%
Total revenue	3 760 159	2 836 309	32,6%
Gross profit: used cars	268 035	171 063	56,7%
Gross profit: wholesale sales	25 881	15 600	65,9%
Other income	255 985	177 205	44,5%
Total gross profit	549 901	363 868	51,1%
Number of markets at the beginning of the period	146	85	71,8%
Number of new markets	115	61	88,5%
Number of markets at the end of the period	261	146	78,8%
Used machinery for sale	171 939	127 179	35,2%
Wholesale Sales	33 406	29 155	14,6%
Average unit price: used cars	18 874	19 426	−2,8%
Average unit price: wholesale	7752	6465	19,9%
Gross profit from the sale of the unit: used cars	1559	1345	15,9%
Gross profit per unit in wholesale sales	775	535	44,9%
Other gross profit	1489	1393	6,9%
Total gross profit per unit	3198	2861	11,8%

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

Company growth metrics

	Number of regional markets	Number of units sold	Gross profit in dollars per unit
2015	9	6523	206
2016	21	18 761	1023
2017	44	44 252	1539
2018	85	94 108	2090
2019	146	177 549	2852
Q1 2020	161	52 427	2640
2nd quarter of 2020	261	55 098	2726
Q3 2020	261	64 414	4056

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 2020	1,4%

Number of vending centers of the company

2015	1
2016	2
2017	7
2018	15
2019	23
Q1 2020	24
2nd quarter of 2020	24
Q3 2020	25

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

	February	April	June	November
Price negotiation	25%	65%	63%	61%
Auto Finance	36%	54%	55%	52%
Valuation of the machine when exchanging	34%	38%	42%	41%
Buying	19%	39%	37%	41%
Test Drive	9%	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.