Everybody loves a new vehicle, but few enjoy the buying process. It's that dislike for how much of the industry does business -- in Carvana Co.'s (CVNA 0.29%) case, the used-vehicle market -- which opens the door for disruption, innovation, and financial rewards for investors. In fact, according to Carvana citing a DealerSocket 2016 report, 81% of consumers don't enjoy the car buying process, which is great news for the company's streamlined online buying model and unique vending machine concept.
With a wave of off-lease vehicles coming that could pressure companies like Carvana, yet an industry ripe for a better way to do business, this is one way Carvana can excel and reward shareholders.
One source of growth
A simple way for Carvana to boost its bottom line, even if a glut of off-lease vehicles weighs on top-line pricing in the future, is to improve its operations and expand its gross profit per unit (GPU). Gross profit per unit is simply the gross profit driven by sales of used vehicles, including the wholesale of vehicles traded in during the purchase, gains on sales of loans to finance the vehicle, and commissions on sales of vehicle service contracts -- it's a key measure of the company's core profitability.
Graphic source: Carvana's August 8, 2017 Q2 letter to shareholders.
As you can see in the graph above, Carvana's GPU increased $332 to $1,501, on its way to management's lofty $3,000 goal. That figure would be comparable to used vehicle selling juggernaut CarMax (KMX 0.63%) which generated $3,323 GPU during its first quarter of 2017. Not only has management been able to drive gross profit per unit higher in recent quarters, it has a plan to continue driving it higher.
Image source: Carvana Co.
Driving gross profit
One key way Carvana can drive GPU is by reducing average days to sale, improving the turnover ratio. The goal is to increase its total number of markets and sales at a faster rate than inventory increases. That will effectively increase the demand for a smaller supply of vehicles, and in theory, help reduce days to sale.
*Q3 2017E points represent the low end of retail guidance range and estimated website units available. Graphic source: Carvana's Aug. 8th, 2017 Q2 letter to shareholders.
A second important way to improve GPU will simply be fully utilizing existing infrastructure. As the company scales in size, it will be able to use more capacity of its existing Inspection and Reconditioning Centers (IRCs), which aren't fully using their combined capacity to process 150,000 vehicles per year. A third way will be cross-selling and creating new products. Management plans to improve its website to better highlight benefits of its financing products, vehicle service contracts, and trade-ins, which all directly improve total GPU.
Brilliant acquisition
Last, but certainly not least, will be optimizing Carvana's used vehicle pricing. It takes years of knowledge and research to properly value a car, and it's a fine line between earning consistent and desirable margins thanks to an optimized price tag, and having a price so high it increases days to sale and becomes counterproductive to GPU. That's the driving force behind Carvana's recent acquisition, which will add years of vehicle valuation, pricing information, and talent to the company's team.
Ultimately, Carvana has an impressive and unique vending machine concept that could lure younger audiences to purchase cars from its major markets. But the core of Carvana will be its capable and fully transactional online website, which offers to deliver vehicles and help consumers avoid much, if not all, of the traditional buying process. Carvana is an incredibly intriguing opportunity even as the auto industry slows in the U.S., and while it's not foolproof, if the company can indeed drive its GPU higher, it will reward shareholders as it expands into new markets.
