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Why This One Stock Could Bring Life-Changing Returns

By Andrew Tseng - Mar 5, 2020 at 9:00AM

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This company's "better mouse trap" should lead to stellar growth ahead.

Carvana (CVNA 10.06%) developed a better way to sell used cars and is rapidly disrupting the used car retail industry. The whole idea of buying a used car online without ever having seen it before sounded at first like a crazy idea, but Carvana's mind-boggling success has proven it is the future of used car retailing. If the company continues to grow and can achieve its long-term profitability targets, Carvana could deliver life-changing returns for shareholders. 

A track record of rapid growth

Carvana is only a seven-year-old company, yet it is already the third-largest used car retailer in the United States. The company launched its innovative model in Atlanta in 2013, has grown revenues at a triple-digit pace for six straight years, and is now operating in 161 markets across the country. Those markets cover 69% of the U.S. population so far, and should further expand to cover 73% to 75% if management's projections prove accurate. 

A young woman being handed car ksys while sitting in a white car.

Image source: Getty Images.

Carvana has been so successful because it beats its competition on three things that matter deeply to customers: selection, convenience, and price. The company has a vastly larger selection of used cars to choose from compared to traditional used car dealers because it pools its national inventory together online. The cars are strategically placed at its seven (and counting) inspection and reconditioning centers (IRCs) around the country, and customers can order any of them. Currently, Carvana has over 36,000 cars available for sale on its website. In contrast, a traditional used car dealer usually has 50, 100, or 200 cars on site.

Carvana offers customers a much better user experience than the traditional way to buy a used car. Instead of visiting used car dealers for multiple hours and having to deal with the hassle of salespeople and negotiating terms, car shoppers on Carvana's website can buy a used car online from home and have it delivered straight to their door. The company's website has a large number of detailed photos of the cars' interiors and exteriors, and even highlights any dings or imperfections so there are no unwelcome surprises. Car shoppers can also arrange financing and trade in their car to Carvana with just a few clicks. 

Finally, Carvana's prices are lower. Management estimates their prices are about $1,000 lower than the competition, on average. What allows that is the company's high fixed cost, low variable cost business model -- essentially, since the company's website and nationwide logistics infrastructure are already up and running, the cost of selling and delivering the next car is relatively low. That allows Carvana to offer lower prices than its traditional-dealership peers.

A long runway ahead 

The most exciting part about Carvana is how much growth it has ahead of it. The used car retail market is so fragmented that, despite its rapid growth to date, Carvana still only has a 0.5% nationwide market share. The single largest player it goes up against, CarMax, only has around 2% market share. The rest of the market is made up of small chains, single retailers, and the person-to-person market. That means roughly 97% of the market can't even come close to competing with Carvana's better selection, convenience, and prices.

While it is impossible to say how large Carvana's market share could be in the long run, the opportunity is massive. That said, it doesn't take huge market share gains for the company to get much bigger. For example, the company's long-term goal is to sell 2 million used cars to its retail customers. Given there are about 40 million used cars sold in the U.S. each year, that would be only 5% nationwide market share. That would grow the company's used car sales by about 11 times and make it the largest used car retailer in the country. And 5% market share is still relatively low for what would be the industry leader. Further upside certainly exists longer term.

A profitable model at scale

Carvana is currently losing money because it is investing so much in growth, but the company is rapidly approaching breakeven. The company's net loss margin was -36.6% in 2014 when it was just getting started, but has improved every year, to -9.3% last year. Similarly, the company's EBITDA margin -- an often-used proxy for cash flow -- was -32.2% in 2014, improved to -5.8% last year, and management expects it to be between -3.5% and -1.5% this year. Further growth in used cars sold should allow the company to reach breakeven in the not-so-distant future.

Longer-term, management expects its revenues to grow much faster than its operating expenses, like advertising, corporate overhead, and depreciation, such that its EBITDA profit margins should be substantially positive, in the 8% to 13.5% range. 

Considering Carvana's growth runway and its profitable model at scale, the company should be multiples larger than its current size over the long term. Investors should consider buying the stock if they want a shot at life-changing returns.

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Stocks Mentioned

Carvana Stock Quote
Carvana
CVNA
$31.52 (10.06%) $2.88
CarMax Inc. Stock Quote
CarMax Inc.
KMX
$98.36 (7.19%) $6.60

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