Superior customer experience with next-day delivery -- or innovative vehicle vending machine experience? Check. Proven go-to-market strategy? Check. Fine-tuned website that enables consumers to purchase a vehicle within 10 minutes? Check. Carvana (NYSE:CVNA) checks a lot of boxes for investors looking for a young company that could flourish in the years ahead, but there's one very important step the company needs to take.
When considering what makes Carvana intriguing as a seller of used vehicles, the first thing that should grab investors' attention is its unique vending machine, which provides some differentiation and an element of fun compared to the traditional dealership experience. The company's most recently opened machine, its 12th, is in Tempe, Arizona, stands nine stories high, and holds up to 34 vehicles. Customers use an oversize coin to activate the vending process -- an experience worthy of sharing on social media, of course.
For consumers who prefer a more traditional internet-based path to purchasing a vehicle, Carvana's website offers a quick and seamless experience with over 11,000 vehicle options, the ability for consumers to trade or sell their existing vehicle, and even personalized financing. Customers can schedule a delivery appointment as soon as the next day. It's a compelling way to purchase a used car and avoid the historical dealership experience.
What Carvana needs to do
Carvana's operations are innovative, but investors need more than that to buy in. And that's where Carvana must consistently show progress on gross profit per unit (GPU). We know Carvana is going to grow its top line as it enters into a slew of new U.S. markets; in fact, Carvana's 44 markets at the end of the fourth quarter of 2017 are expected to explode to as many as 84 by the end of 2018. But it also needs to narrow the gap with its competitors on GPU. Let's use CarMax (NYSE:KMX), a competitor that logged an excellent 2018 first quarter, as an example.
Carvana's retail used-car GPU checked in at $902 during the first quarter of 2018, a massive improvement from the prior year's $555, but a far cry from CarMax's $2,215 per unit. The story is much the same for both companies' wholesale vehicle GPU: Carvana's checked in at $73, another large improvement over the prior year's $19, but far below CarMax's $1,012. While Carvana has a long way to go to catch more established competitor CarMax in GPU, it has made substantial improvement since 2014.
Carvana has made progress generating higher total GPU on the march toward its $3,000 medium-term target, which narrows the gap between its Q1 2018 total GPU and CarMax's Q1 2018 total GPU of $3,333. To continue this, management needs to reduce average days to sale by increasing the number of markets it participates in, and the total sales, at a faster rate than it increases inventory. After management becomes satisfied with the rate of its market entry growth with levels of inventory, it then needs to grow into its inspection and reconditioning center capacity, and continue to increase inventory at a healthy rate. Carvana currently has four facilities with the collective capacity to inspect and recondition roughly 200,000 vehicles annually. For context, that's more than twice the 90,000 to 94,000 retail sales Carvana has forecast for 2018.
Ultimately, if there's one metric investors need to keep an eye on, it's GPU. That's simply because we can expect, or at least certainly hope, that Carvana's top line will continue to post explosive growth as it aggressively expands into new markets. We can also expect expenses to rise as it does so, making profitability difficult in the near term. But for its long-term potential to reward shareholders, it must spend to enter new markets so it can grow into its capacity and reach more consumers, while increasing inventory at a healthy rate to improve GPU at the same time -- that's how Carvana becomes a more lucrative business. And that's how investors will win in the long term.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Daniel Miller has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon and CarMax. The Motley Fool has a disclosure policy.