Carvana Might Be a Buy — Just Not Yet

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Companies that conduct most of their business online were heavily favored by investors in 2020. The pandemic disrupted consumer habits and drove massive benefits for businesses that could adapt — or that already were well-adapted — to the new realities. Carvana (NYSE:CVNA) grew to become the second-largest used car dealer in America thanks to its e-commerce model.

The company’s sales and revenue grew materially, and investors flocked to the stock, driving it 740% higher from the low point it touched in March 2020. It’s an exciting story, but Carvana continues to lose significant amounts of money. It is improving in some areas, though, so the stock is worth watching as the business moves toward profitability.

Smiling man sitting in his newly delivered car and receiving the keys in his hand

IMAGE SOURCE: GETTY IMAGES

Major tailwinds for used car sellers

Carvana sells used vehicles through an entirely online process, except if customers choose to visit one of the company’s 28 “vending machine” locations for a test drive. It operates in 272 U.S. markets. When a customer makes a purchase, the company delivers the vehicle directly to the buyer.

Since 2014, Carvana’s annual revenues have grown by 133 times to over $5.5 billion in 2020.

The pandemic created some massive supply chain disruptions for automakers, and now, semiconductors shortages are expected to constrain vehicle manufacturing for the next two years. New car dealers have struggled to keep their lots stocked, with inventories down by more than 80% in some cases.

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This has led to a frenzy in the used car market, with consumers scrambling to make purchases from the limited offerings of private sellers. Analysts at Edmunds have estimated that the average used vehicle sale price is now above $20,000.

Carvana’s sales growth demonstrates how it has benefited from this environment.

Quarter

Units Sold

Growth
(Sequential)

Q1 2020

52,427

4.1%

Q2 2020

55,098

5.1%

Q3 2020

64,414

16.9%

Q4 2020

72,172

12%

Q1 2021

92,457

28.1%

DATA SOURCE: COMPANY FILINGS

Carvana’s immediately available inventory remains low, down about 63% from its peak in 2020. If this continues, it may find itself facing similar issues to those of new car dealers. But in Q1, Carvana opened its 12th inspection and reconditioning facility, bringing its total processing capacity to 680,000 vehicles per year — which will help alleviate some of the pressure from vehicle shortages — and it intends to double this capacity by the end of 2022. 

Optimism for improving financials

The combination of high prices for used cars and supply constraints for new ones helped to bolster gross profit margins for Carvana. Its total gross profits per vehicle hit a record high of $3,656 in Q1 — up 12.4% from just the end of 2020. The company’s main issue is that it’s still losing money per car on a net basis because it is spending heavily on expansion. But its net loss margin has shrunk to 3.7% — and has been shrinking steadily since 2014 as the number of cars sold increased — so this does appear to be a scale story.

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Additionally, later this year, the company could deliver positive quarterly EBITDA margins for the first time ever. 

Metric

2018

2019

2020

Q1 2021

Long-Term Target Range

EBITDA margin

(10.5%)

(6.2%)

(4.6%)

(1.3%)

8% to 13.5%

DATA SOURCE: COMPANY FILINGS

Losing $462 million in 2020 was not a positive result, and the company’s annual losses have grown over the last few years despite its rising sales. That said, the trend in its margins provides a reason to be bullish over the long term. The company has invested aggressively in growth, almost tripling the number of markets it operates in, and quadrupling its number of unique monthly website visits, in just the last three years. 

It’s unclear whether sales will continue to grow at the current accelerated pace, once the effects of new car shortages have worn off. Since Carvana has invested so aggressively in new facilities to boost vehicle capacity, there is a risk that growth won’t keep up, which could widen the company’s net losses. It’s betting on the stickiness of its model — that it has permanently disrupted the way people buy cars, and it will be the preferred vendor going forward. 

Investors might benefit from waiting a couple of quarters to see how sales change, and more importantly whether the company can continue inching its EBITDA margins toward positive territory. A combination of continued sales growth and positive margins once the economic environment is more normal, could be a green light for investors to pull the trigger on this stock. 

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This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.



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