Shares of online used car seller Carvana (CVNA 1.24%) rocketed higher last week after the company updated its outlook for the second quarter. Carvana now expects to report adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) of at least $50 million, compared to a previous outlook calling for positive adjusted EBITDA. The company also sees its non-GAAP (generally accepted accounting principles) total gross profit per unit metric exceeding $6,000, which would be a new record and up 63% year over year.
While the market cheered this improved outlook, there are two very important things to know.
NYSE: CVNA
Key Data Points
1. Adjusted EBITDA is a bad profitability metric
What is adjusted EBITDA? To calculate EBITDA, take a company's net income and add back interest, taxes, depreciation, and amortization. The "adjusted" part involves backing out even more expenses, often stock-based compensation.
EBITDA can be useful for comparing companies in the same industry with different capital structures, but as a profitability metric, especially one that management uses to drive decision-making, it's problematic, to say the least.
For one, interest, taxes, depreciation, amortization, and stock-based compensation are real expenses. Capital expenditures aren't free. Debt must be serviced. Stock options dilute shareholders.
For Carvana, the gap between adjusted EBITDA and anything more closely resembling a true accounting of profitability -- net income or free cash flow -- is enormous. In the first quarter, while adjusted EBITDA was a loss of just $24 million, net income was a loss of $286 million, and free cash flow was a loss of $98 million. Free cash flow, which represents the actual cash generated by operations minus capital expenditures, was boosted by a big reduction in inventories, which can't be repeated every quarter.
Carvana had $8.5 billion of debt as of March 31, and it paid $159 million in interest on that debt in the first quarter alone. Adjusted EBITDA completely ignores this expense.
2. Gross profit per unit is not what you think
Carvana sells vehicles at retail and through its wholesale operations. When the company talks about "total gross profit per unit," one would think calculating this metric would involve taking the total gross profit generated and dividing it by the total number of units sold. One would be wrong.
Instead, Carvana takes the total gross profit generated, which includes contributions from retail vehicle sales, sales of loans, and wholesale vehicle sales, and divides it by the number of retail vehicles sold. Imagine if Best Buy reported a "total gross profit per TV sold" metric that took the company's total gross profit from everything it sold and divided it by the number of TVs sold. That's essentially what Carvana is doing here.
To be fair, the constituent parts of this metric improved during the first quarter. But it's a bizarre metric to latch onto. One way to increase it would be to funnel as many cars through the wholesale channel as possible. The wholesale units aren't a factor, but the total gross profit they generate is included.
The wrong goalposts
Carvana is measuring its turnaround effort with two deeply flawed metrics. Both are moving in the right direction, but that just doesn't mean much.
The concerning thing for investors should be that these metrics are driving management's decisions. A profitability metric that ignores crushing interest payments, among other things, and a gross profit per-unit metric that uses an inventive definition of the word "unit" are guiding the company.
In short, management is focused on the wrong things, and that's enough of a reason to avoid the stock.
