You would think a deadly pandemic might put a damper on big-ticket purchases like car sales. And you'd be right. But not if you're talking about used cars -- and especially not if you're talking about online sales of used cars.
Carvana (CVNA -5.89%), the pioneer of selling used cars entirely online, is seeing unprecedented demand growth as more consumers flock to the online car-buying experience.
The problem is that Carvana doesn't have enough cars to sell. But as the company ramps capacity, it should see sales growth accelerate sharply from its recent pace. Here's the situation.
Paused buying cars
Carvana has grown at a blistering pace since it launched in 2013. The company sold 2,105 cars in 2014 and grew that figure an incredible 84 times to 177,549 cars last year. That's an average annualized growth rate of 143% for five years.
But COVID-19 threw a monkey wrench in that track record of growth. Sales began to fall in the latter half of March as the virus spread and were running down 30% year over year in early April. Given Carvana's leveraged balance sheet and still-negative free cash flow, management had a choice to make.
It could have continued buying, reconditioning, and listing cars for sale as if it were business as usual. Doing so could have potentially put the company in a dicey liquidity position if sales continued falling. Or it could have retrenched by pausing car buying and selling down inventory, raising cash. Management took the latter, more conservative approach, which was probably the right decision given the knowledge it had at the time.
The demand surge
Few people would have expected what came next. The 30% year-over-year declines seen in early April turned out to be the bottom, and sales began to improve consistently thereafter. In late April and early May, sales bounced back strongly, rising 20% to 30% year over year. By the end of the second quarter, sales were growing 40% year over year, and that strength continued into July.
The problem with this unexpected and rapid demand recovery is that management had taken the conservative approach and paused buying cars in March. That left Carvana dramatically short of inventory when demand snapped back. Available cars on the company's website that weren't already labeled as "pending purchase" went from 21,000 in mid-March to 11,000 in mid-May to just 5,000 as of late July. Fewer cars available for sale means fewer sales.
Scrambling to produce cars
Carvana is now doing everything it can to produce -- buy, recondition, and make available for sale on its website -- as many cars as quickly as it can.
To help ramp production capacity, Carvana recently opened its ninth inspection and reconditioning center (IRC) near Columbus, Ohio. That IRC brings the company's total annual capacity to nearly 500,000 cars, assuming full utilization of its facilities. And the company intends to open two more IRCs before the end of this year, which should further increase annual capacity to 600,000 cars. These are big numbers compared to the 204,308 cars the company has sold to retail customers over the last four quarters, and will allow for substantial growth.
Fortunately, Carvana has access to plenty of cars to buy. That's especially true now that the company has significantly ramped up the number of cars it buys from customers as opposed to at auctions. The biggest bottleneck has been its ability to inspect, recondition, photograph, and get those cars available for purchase on its website. That's been held back by COVID-19 waves across the Sun Belt, where several of the company's IRCs are located.
But those outbreaks should eventually get under control. In the meantime, the company is hiring and training more IRC personnel as quickly as it can to help produce cars. And it is significantly increasing capacity in its logistics and last-mile delivery network.
The exciting thing for Carvana is that available inventory is the only thing preventing explosive sales growth. Customer demand for its cars is through the roof now that COVID-19 is "normalizing" buying a car entirely online. In fact, a recent CarGurus survey indicated 60% of respondents were open to buying a car online versus just 32% prior to the COVID-19 pandemic.
Carvana just needs to fulfill demand. CEO Ernie Garcia said the following on the second-quarter conference call:
And we think that in the immediate term, at least, our ability to produce cars is going to directly drive the number of cars that we're able to sell. And it feels like we've got this amount of room there. So we're focused on production right now. If we can get that figured out, we think that demand will continue to grow pretty rapidly.
Investors should expect Carvana's vehicle sales growth to soar from its recent 40% year-over-year pace as the company ramps production and fulfills more of the sky-high demand it is seeing.