Vroom (NASDAQ:VRM) stock was looking like a lemon after its first earnings report as a publicly traded company.

The online used car dealer was well-received in its June IPO -- shares doubled out of the gate before tacking on another 50% ahead of the second-quarter results. However, investors were clearly disappointed with what they saw on Thursday; the stock fell as much as 23% on the news.

The headline numbers

  • Overall revenue fell 3% to $253.1 million, which beat estimates for $234.9 million. Revenue in the key e-commerce segment (Vroom's growth business) rose 45.2% to $175.6 million.
  • Average vehicle selling price fell by 17.4% to $25,393, and gross profit per e-commerce unit slumped 43.2% to $1,075.
  • Adjusted EBITDA loss widened from $29.8 million to $39 million, and an adjusted loss of $0.34 per share, though that was also better than estimates of a $0.70 per share loss.

Though the company beat estimates, investors seemed concerned about the sharp drop in average selling prices and gross profit per unit, as well as guidance that forecast average selling prices would fall further to $23,500 in the third quarter. The bigger concern, however, was that management predicted Q3 revenue would decline by 15% to 21% to a range of $268 million to $290 million, well below analysts' consensus expectation of $344.6 million. However, because of the components of the company's business, which include physical location and wholesale channels, that forecast is a bit misleading. We'll get to the details about why later.

COVID-19 had Vroom spinning its wheels

"In response to the drop in demand and uncertainty around vehicle pricing early in the pandemic, we chose to de-risk the business by significantly reducing our inventory during the first half of the quarter," said CEO Paul Hennessy. "As demand increased and pricing became more stable through the second half of the quarter, we pivoted to start rebuilding inventory and continue to do so. These lower inventory levels prevented us from fulfilling all of the demand that materialized in the second half of the quarter."

The impact of the pandemic on Vroom has been similar to its effects on e-commerce car sales leader Carvana (NYSE:CVNA). It too has found demand is now outstripping supply as the necessity of social distancing has led to more people needing their own vehicles. 

A Vroom delivery truck

Image source: Vroom.

Rising demand for cheaper vehicles

It would be an understatement to say the second quarter was unusual. The company responded to the initial impact of the coronavirus pandemic by selling down inventory at lower-than-normal prices in order to avoid holding an excessive number of aging used cars. On the earnings call, Hennessy said Vroom reduced its inventory from $200 million to $70 million, which impacted both average selling price and gross profit per unit.

Because of the spike in demand that has accompanied economic reopenings across the country, Vroom is now struggling to rebuild its inventory. That's having an impact on conversion -- i.e., the percentage of customers who come to the e-commerce site and then buy a car there. Demand has also shifted to lower price points, which helps explain why guidance calls for a $23,500 average selling price in Q3 as the company stocks its inventory with less-expensive vehicles. Management had anticipated that the average selling price would decline over the long term as it penetrated the used car market more deeply, but the pandemic seems to have accelerated that shift as growing numbers of Americans now need cars of their own.

No reason to sell

Given the changes in consumer demand, the company's lower average selling price doesn't seem like a problem, and management said that the gap between higher demand and lower inventory is allowing the company to capture greater gross profit per unit. In fact, the company is targeting gross profit per unit in the $1,600 to $1,700 range in the third quarter, much higher than the $1,075 it posted in the second quarter, and slightly ahead of the $1,577 it had in the quarter a year ago.  

Meanwhile, the company expects to sell between 8,500 and 8,800 vehicles via its e-commerce channel this quarter, up by about 55% from a year ago. That puts the company in position to increase its e-commerce gross profit by close to 60% in the third quarter, and it's calling for total gross profits of $16 million to $18 million, ahead of the $15.7 million it earned in the quarter a year ago.

Investors seemed focused on the forecast decline in overall revenue in the third quarter, but that pessimism is driven by the results from its single physical retail location, Texas Direct Auto, which is experiencing a sharp drop in sales as more consumers avoid visiting physical dealerships, and in the wholesale channel, which the company uses to sell trade-in vehicles that don't meet its standards.

With an expected 60% increase in e-commerce gross profit in the third quarter, the key component of Vroom's business remains strong. While a forecast decline in average selling prices and overall revenue in the third quarter may be understandable reasons for traders to sell off the stock -- especially after its post-IPO surge -- those issues don't reflect long-term headwinds for the company.

Investors should remain focused on the e-commerce division, which continues to deliver strong growth during uncertain times.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.