We Were Wrong About Carvana (CVNA)

We rated Carvana (CVNA) 1/10 in late November 2022 due to its $9.2 billion in liabilities from pandemic expansion. 

Rising rates and a softening used-car market sent shares from $375 to $5, leading creditors to prepare for debt restructuring.

With the screws put to them, Carvana implemented a bold turnaround strategy focused on cost reduction, operational efficiency, and debt restructuring.

Management slashed costs through layoffs and reduced advertising spending, leading to a 34% decrease in selling, general, and administrative expenses. 

These efforts, combined with improved gross profit per unit and a focus on profitability over growth, resulted in a remarkable financial turnaround. 

Since mid-2023, shares have risen by as much as 3,700%, with the company’s latest earnings pushing shares up to $260, a 23% increase overnight.

Interest among financial pros and retailers increased as Carvana’s business improved, according to our TrackStar data.

The stock isn’t cheap at 202x and 39x forward earnings and operating cash flows.

But is there somewhere that it makes sense to purchase shares?

Carvana’s Business

Carvana has transformed from a startup experiment to the nation’s second-largest used car retailer in just a decade. 

The company’s iconic car vending machines and home delivery service have reimagined the traditional dealership model, offering a fully digital car-buying experience.

Operating as an e-commerce platform for used vehicles, Carvana enables customers to browse over 30,000 vehicles, secure financing, complete trade-ins, and arrange delivery or pickup across more than 300 U.S. markets.

Carvana segments its business into the following revenue streams:

• Retail Vehicle Sales (70% of total revenues) – Sales of used vehicles directly to consumers through their e-commerce platform
• Wholesale Vehicle Sales (21% of total revenues) – Includes vehicle sales through wholesale channels and their ADESA auction business
• Other Revenue (9% of total revenues) – Primarily consists of financing, vehicle service contracts, and other ancillary products

Q3 results showed 34% YoY growth to 108,651 vehicles and $148 million net income with 11.7% adjusted EBITDA margin.

A key strategic focus involves leveraging their 2022 acquisition of ADESA, a nationwide network of 56 physical auction locations. 

They’ve integrated Carvana operations into just 5 ADESA sites, with plans to expand the network. This integration reduces transportation costs, improves delivery times, and strengthens relationships with commercial partners.

The company continues to optimize its reconditioning operations, which can now support an annual production capacity of over 1 million retail units. 

Despite their rapid expansion, Carvana maintains just 1% market share in the massive used car market, suggesting substantial room for continued expansion.

Financials

Source: Stock Analysis

Carvana’s 2017 IPO was followed by years of exceptional sales growth. Yet, it burned through cash every year onward, culminating in 2021 with $2.6 billion cash drain.

The turnaround instituted in 2022 reduced the cash consumption to $1.3 billion. By 2023, Carvana generated $803 million in cash from operations.

From Q1 2022 to Q4 2023:

• Advertising: $155M → $59M
• Logistics: $56M → $26M
• Compensation: $256M → $162M
• Other operating: $237M → $176M

Management expects to accelerate their year-over-year growth rate in the fourth quarter while significantly exceeding their previous full-year adjusted EBITDA guidance of $1.0-$1.2 billion. 

These projections reflect growing confidence in their business model’s ability to generate both growth and profitability as they scale operations.

Meanwhile, total debt has decreased to $6.2 billion, as management has paid down around $60-$70 million per quarter, though they have not outlined plans for the future.

Valuation

Source: Seeking Alpha

Carvana should finally turn a P&L profit next year. Yet, its P/E ratio far exceeds any of its automotive peers. 

Even its 39x forward price-to-cash flow ratio is above all its peers, save for AutoNation (AN), which trades at 49x and 39x current and forward operating cash flows, respectively.

The premium valuation reflects high growth expectations.

Growth

Source: Seeking Alpha

Carvana is the only company in this group to put up double-digit sales growth YoY.

The forward revenue outlook of just 4.7% isn’t that great, even if it’s higher than all the others on this list except O’Reilly Automotive (ORLY).

However, we believe this underestimates next year’s revenues, which we see as closer to +20% YoY based on current analyst estimates.

Profitability

Source: Seeking Alpha

Carvana has done an excellent job improving its margins, with EBIT now at 5.5% and growing with a positive free cash flow margin of 2.3%.

However, the company has a long way to go compared to its peers. While we don’t expect them to run the same gross margins, we do expect EBIT and EBITDA to improve as D&A expenses decline over the years.

Our Opinion 6/10

Carvana has done substantially better than we expected. However, they still face serious challenges, including a softening economy and high interest rates.

Yet, we see substantial upside potential if management can continue improving operations and cutting costs. This depends on how the company optimizes its purchase and reconditioning operations and its marketing tactics.

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