Carvana (NYSE:CVNA), the online used car seller known for its unique vending machines, has been one of the best-performing stocks on the market since its 2017 IPO, rallying a remarkable 947% since then.
The stock has been propelled by an incredible streak of triple-digit revenue growth, which came to an end last November at 23 straight quarters. While its revenue growth has no doubt been impressive, the stock has been dogged by a lack of profitability, and some critics believe the company will never turn a profit, alleging that the business model is fundamentally flawed. Is Carvana really a lemon? Let's take a closer look.
What the critics say
The most popular critique for Carvana seems to be that the used car market is already efficient, so there is little opportunity for the company to generate bumper profits as it can't beat competitors on cost. Detractors also draw comparisons to Beepi, a online used car marketplace that failed in 2016, though that company was founded after Carvana.
Additionally, they point out that Carvana lost $1,500 on every car sold last year, taking overhead costs into account, and even conventional dealers tend to make only a slim profit. Carvana's net loss has also consistently widened as it's grown. In fact, last year it lost nearly $1 billion in free cash flow, and reported a loss of $364.6 million -- though less than a third of that loss was attributable to Carvana Co. common stockholders, with the remainder belonging to LLC unitholders owning other classes of stock.
While Carvana's losses are reasons for concern, the above critiques overlook several factors.
First, the failure of rivals like Beepi doesn't really mean anything for Carvana's prospects, as one failure doesn't necessarily indicate a bad business model. Amazon emerged from a dot-com bust that killed many of its rivals, including Webvan, Urban Fetch, and Kozmo.com, and is now the second-biggest company in the U.S. by sales. Execution matters more than the category.
Second, Carvana's losses may be widening, but its margins are improving. Used vehicle profit per unit increased $1,043 to $1,368 from 2018 to 2019, and total gross profit per unit, which includes customer financing and a small amount of wholesale revenue, improved from $2,133 to $2,883. Growth in that metric is key to driving overall profit, and management had originally called for total gross profit per unit to reach $3,200 to $3,400 this year before it pulled its guidance because of the COVID-19 pandemic.
Finally, the claim that the used car market is efficient seems foolish. Though it may be efficient on a cost basis, consumers generally dislike the experience, leaving it ripe for disruption from online operators like Carvana and recent IPO Vroom. If the industry were efficient and there were no room for improvement, Carvana's sales wouldn't have doubled for 23 straight quarters to reach nearly $4 billion last year.
How Carvana sees it
Management isn't ignorant about the questions around its profitability. The company finished last year with $883 million in debt and $76 million in cash, and has already done multiple secondary offerings and debt raises.
However, management has laid out a strategy to reach profitability along with specific targets, which include gross margin of 15%-19%, selling, general, and administrative expenses of 6%-8%, and Adjusted EBITDA margin of 8%-13.5%. In its prior guidance, management forecast Adjusted EBITDA margin narrowing from -5.8% last year to between -3.5% and -1.5% this year.
In order to get there, the company aims to grow gross profit per unit, improve operating leverage, and grow retail units and revenue. The company has been able to do all three of those things, and they are helping it bring its operating margins closer to breakeven. Over the long term, the company believes it can reach 2 million cars sold annually, up from less than 200,000 last year.
Carvana has also seen dramatic improvement in acquiring vehicles from customers, which helps lower costs and improve profits. Last year, vehicles acquired from customers jumped 231% to more than 104,000, a trend that should also help it reach profitability.
Will Carvana get out of the red?
Carvana's cash burn may be starting to strain the business -- the company's interest expense reached more than $80 million last year, adding to its losses. However, while profitability is a legitimate concern, a better question to ask may be how long the company can continue growing its revenue at such high rates.
In the first quarter, revenue jumped 45%, a noticeable slowdown from recent quarters, as the company was impacted by the COVID-19 pandemic. Management noted that the impact continued into the second quarter, with sales down about 30% in early April as much of the country went into lockdown. However, in late April and early May, sales growth returned to 20%-30%, a promising sign for a rebound. May's retail sales report also showed auto sales bouncing back, as sales in the category fell just 3.9% year-over-year, compared to a 33% plunge in April.
Though its online-only model is seen as a liability by critics, that looks to be an advantage during the pandemic as car shoppers can avoid visiting dealerships and potentially exposing themselves to the virus. E-commerce sales have soared in nearly every category during the pandemic, and there's no reason why cars would be an exception. That tailwind could help push the company closer to profitability.
With sales surging and the stock again at all-time highs, it's clear that customers and investors love Carvana. With its valuation near $20 billion, management can dilute shareholders again if it needs to raise more capital, as they seem eager to fund the company's growth. Profitability might not come soon, but it should come eventually based on Carvana's current trajectory. More importantly, as long as revenue growth remains strong and margins improve toward breakeven, the stock should continue to rise as the company chases a market opportunity worth close to a trillion dollars.