Carvana (“CVNA”) – The Investor Weekly Stock Report

Summary

Carvana has significantly disrupted the traditional model of used car sales. Digitalizing the car market has paid off and the dealer is now the second largest used auto dealer in the country. Carvana stock has dealt with a good deal of arguments on both side. Let’s dive in now.

Investors have piled into the stock sending it up 1,000% since pandemic lows of Q1 2020. The Company has grown full-year Sales figures by more than 600% since 2017.

It’s an exciting story, but Carvana has only recently turned a Quarterly profit. Wall street analysts have issued conflicting recommendations on the stock, and there’s a good argument for investors to potentially cash in on some of their gains here.

Investors may benefit from waiting a few quarters to see how sales and EBITDA change. It just delivered its first-ever quarter of positive net income, but there are signs the favorable market conditions buoying its results are heading in reverse. There’s a chance that certain economic and statistical factors will lead to a downturn in the stock price for the second half of this year.

Historically, long-term strength in used car prices is not a trend that investors can bank on, so investors may want to tread carefully.

Concerning Valuation Levels

Investors should consider the consequences of Carvana’s cars in inventory potentially falling in value, as opposed to appreciating.

I won’t challenge the fact that Carvana’s growth has been impressive. However, the current valuation, rising debt levels and the cyclicality of the auto business give investors pause. We believe that a combination of positive sales growth and EBITDA margins could be the green light that investors need to pull the trigger on this stock. For investors focused on the long-term, the coming downward shift in used car prices may not hold the Company back.

Historically, long-term strength in used car prices is not a trend that investors can bank on, so investors may want to tread carefully. Investors should consider the consequences of Carvana’s cars in inventory potentially falling in value, as opposed to appreciating.

I won’t challenge the fact that Carvana’s growth has been impressive. However, the current valuation, rising debt levels and the cyclicality of the auto business give investors pause. We believe that a combination of positive sales growth and EBITDA margins could be the green light that investors need to pull the trigger on this stock. For investors focused on the long-term, the coming downward shift in used car prices may not hold the Company back.

Company Overview

Carvana was founded in 2012 and took five years to sell its 100,000th car. It just topped 100,000 in a single quarter for the first time, representing 96% year-over-year.

As a technology company harnessing the power of the internet, it can sell more cars using less fixed costs and therefore profit margins balloon as that volume climbs.

CVNA sells vehicles through an online process. It also offers “vending machine” locations where individuals can test drive a vehicle. CVNA currently operates in 272 US markets. When a customer purchases a vehicle, CVNA will deliver the car directly to the buyer.

Selling and valuing a car traditionally requires a physical inspection.  But Carvana has removed the hassle.

CVNA has adopted artificial intelligence both organically and through acquisitions. And they are using it to dominate their industry.

The license plate and a few other details are all that is needed to get a valuation back. This is made possible by big data and machine learning. CVNA monitors sales at used car auctions to detect in-demand vehicles and improve the accuracy of their pricing / valuation algorithm.

Leadership

Ernie Garcia, III co-founded Carvana and has served as the President and Chief Executive Officer since 2012. Mr. Garcia is also Chairman of the Carvana Co. Board. Prior to founding Carvana, Mr. Garcia held various roles at the DriveTime Automotive Group, Inc. from January 2007 to January 2013.

Prior to DriveTime, Mr. Garcia was an associate in the Principal Transactions Group at RBS Greenwich Capital from 2005 to 2006, where he focused on consumer credit-based investments.

Ownership Structure

Market

Companies that conducted most of their business online were heavily favored by investors over the past two years. Carvana (NYSE: CVNA) great to become the second-largest used car dealer in the US due to its innovative e-commerce model.

COVID has created massive supply chain disruptions. And semiconductor shortages are likely to constrain vehicle manufacturing for the next two to three years. Dealerships are struggling to keep their lots stocked and inventories are down by up to 80% in some cases.

The used car market is red hot and consumers are competing to make purchases from a limited number of offerings from private sellers. The Company has invested heavily in growth. It has almost tripled the number of markets that it now operates in over the past three years. CVNA has also quadrupled the number of unique monthly web visits in the last three years.

Management recently predicted that Carvana is “on the path to… delivering more than 2 million cars per year, and to becoming the largest and most profitable automotive retailer.”

Risks

CVNA’s available inventory remains low, down about +60% from its peak in 2020. The Company may find itself facing similar issues to those of new car dealers. To remedy this, in Q1 2021, Carvana opened its 12th inspection and reconditioning facility, bringing its total processing capacity to 680,000 vehicles per year. CVNA intends to double this capacity by the end of 2022.

Used car prices rose 10% in April, and then 7.3% in May, however it appears prices could be about to top out. The Manheim wholesale index, which measures the prices paid by used car dealers who buy in bulk, has rolled over and begun to shrink. The index peaked at 203.0 in May and has now fallen for two straight months, coming in at 195.2 in July. Additionally, the highest point of year-over-year growth occurred in April when prices were up 54%, a rate which has now slowed to just 23%.

A Focus on Used Car Demand

Cox Automotive data also shows used car sales were down 15% in July, while new car sales were up 4%. This would seem to suggest that the supply backlog might be abating. Carvana only sells used cars and has benefited from soaring demand, but there’s mounting evidence the used car market may be slowing. Additionally, according to the University of Michigan Survey of Consumer Sentiment, just 41% of respondents thought it was a good time to buy a car in June, a major drop from the 68% in June last year. This was the lowest reading in the last 12 months. If prices continue on this trajectory, Carvana could lose some of the record-high gross margins it has built through the pandemic. The main issue is that the Company is still losing money per car on a net basis because it is spending heavily on expansion. Carvana lost $462 million in 2020, and small annual losses have grown over the years. But we believe a positive trend in its margins provides a reason for

long-term investment.  CVNA’s net loss margin continues to shrink and they’ve been doing so since 2014.

Analysts are still looking for the Company to deliver. It remains unclear as to whether sales will continue to accelerate at these levels, especially once the effects of new car shortages have worn off. There’s certainly the risk that new growth won’t keep up, which has the potential to widen net losses.

Short interest also sits at 20.8% with some 16.2 million shares sold short.

Peers

Vroom (“VRM”) operates an e-commerce platform for buying and selling of new and used cars in the US. VRM growth rates and profitability lag behind Carvana’s. The company was formerly known as Auto America in 2015 and was first incorporated in 2012. VRM is down nearly 40% year-to-date. The company appears to be on a very different trajectory. Between the two, we believe CVNA to be the better long-term play and the company we would recommend investing in.

It is worth noting that CVNA’s current EV represents a 5.5x multiple of revenue, which is nearly 5.0x more expensive than zoom. This begs the question: do you want to be holding CVNA at current market highs? Other stocks that we recommend in the sector include AutoNation (AN), Asbury Automotive (ABG) and Lithia Motors (LAD).

Financials and Valuation

The combination of high prices for used cars and supply constraints are helping the company to bolster profit margins. Gross profits per vehicle is on the rise. And the Company could deliver positive annual EBITDA for the first time ever. However, analysts are predicting a full-year loss of $1.67 per share. This indicates that they don’t anticipate material profits for the last two quarters. Next year, analysts believe that CVNA should inch closer to breakeven, with a narrower loss of $0.65 per share expected.

On August 5, the Company posted second quarter earnings. Analysts were projecting a loss of $0.41 per share on sales of just over $2.4 billion. CVNA posted exceptionally strong results and set a new milestone – Net Income came in at $45 million, working out to $0.26 per share on revenue of $3.3 billion. Revenue nearly tripled from Q2 2020. CVNA flipped from $0.62 per diluted share loss a year ago.

In the first quarter of 2021, the Company sold over 92,000 cars, which was an increase of 76% year-over-year. In Q2, the company sold more than 107,800 units, with gross profits soaring per unit from $2,400 to $5,120 per vehicle. The company sold nearly twice as many cars and trucks in Q2 2021 as it had back in Q2 2020. Unit sales increased by 96% and revenue nearly triple by 198%.

Looking Into 2022

CVNA has predicted that the second half of the year should continue at heightened levels. Management cited that the upper limit would be its own operational capacity to make sales. The Company solidified that it can keep up with demand and anticipates growth in 2022 and subsequent years

Shares jumped 11% after the earnings report and settled down around 3% by the next day.

CVNA has significantly increased its use of leverage and the build-up of short-term debt has become a primary concern. The Company also recently priced $750 million in long-term debt to cover general corporate courses, which means it will cover short-term obligations from operating income. This will stress CVNA’s ability to generate free cash flow.

I don’t feel that the market is pricing in the fundamentals of this stock. And this makes sense, as this is a growth story. Now, however, that EBITDA margins are positive, fundamentals may begin coming into play in the coming quarters. The Company doesn’t have a P/E ratio as it’s not yet profitable on an annualized basis. Its PEG is also unfavorable.

Is CVNA too expensive? Carvana has a market cap of $60.8 billion. And an EV of $63 billion. This means that CVNA is worth more, at this moment in time, than Ford on a market cap basis.

Enterprise Value

Price / Sales (TTM)

Analyst Recommendations

J.P. Morgan analyst Rajat Gupta downgraded Carvana shares to neutral from overweight. The bank’s price target remains at $325. So, this could be interpreted as a valuation call, since the stock effectively hit the price target and there were no new developments at Carvana to suggest it deserved an upgrade (in the short term). Gupta made this call in June. The stock has since hit a side high of $376 and is trading in the $350s range. Conversely, Jefferies maintained its buy rating on the stock and raised its price target from $375 to $400. The firm cited the main driver being the current marketplace for used vehicles; persistent demand for used cars and low supply should continue to bode well for Carvana. 

CVNA Investment Strategy

The Company remains on track to deliver a positive annualized EBITDA in the coming years. The Investor Weekly believes that it will bring a solid reward to investors that have remained patient and held their investment. The Investor Weekly believes that this should be the center of focus for investors. If Carvana continues to double revenues each quarter, it will build the scale it needs to be profitable over the long term. Carvana carries with it a tremendous amount of momentum and this may not be the time to build a position in the stock, especially if this is your initial entry point.

For more stock-specific articles, check out our Buy List, showcasing some of the top-performing companies in the markets!

Total Return YTD

References

Carvana – Investor Relations
https://investors.carvana.com/investor-resources/shareholder-letters

Motley Fool Premium
https://www.fool.com/premium/company/NYSE/CVNA/

Seeking Alpha Premium
https://seekingalpha.com/symbol/CVNA

StockCharts.com


Disclosure
I am/we are long Carvana (“CVNA”) either through stock ownership, options, or other derivatives. 

I wrote this article myself, and it expresses my own opinions, I am not receiving compensation for it, and I have no business relationship with any company whose stock is mentioned in this article.

Nothing on this site nor any published commentary by The Investor Weekly is intended to be investment, tax, or legal advice or an offer to buy or sell securities. Information presented is believed to be factual and up-to-date, but we do not guarantee its accuracy and should not be considered a complete discussion of all factors and risks. Data quoted represents past performance, which is no guarantee of future results. Investing involves risk. Loss of principal is possible. Please consult with your investment, tax, or legal adviser regarding your individual circumstances before investing.