Carvana: Groupthink
Is it right?
Carvana reported its fourth quarter results last week. Here’s Ernie’s shareholder letter.
I was about to write that Carvana is a super controversial stock, but that implies it’s hotly debated among the bulls and bears. I don’t really see that. Most seem to assume Carvana is going to declare bankruptcy shortly and any bulls that remain are in hiding. When sentiment gets that one-sided, I think it’s worth taking a close look while trying to be objective. Because if sentiment happens to be plagued by groupthink, flawed analysis, or little analysis at all, and things end up ok, that’s how career-defining investments are possible. Or sentiment could turn out absolutely correct, even if a lot of it hasn’t been thoughtfully considered, leading to a total loss. Interested? Read on.
Liquidity Picture
In case it is unclear, it should be stated upfront that Carvana is not declaring bankruptcy imminently. They still have a good amount of immediately available liquidity as you can see here.
There are certain minimum restricted cash requirements that currently reduce true liquidity to some extent. But there’s also another more than $2 billion of unpledged real estate assets and beneficial interests in securitizations that could likely be monetized if or when necessary. And management is moving as fast as possible to cut costs and improve profitability to minimize cash burn.
4Q Review
Retail units declined 23.0% year-over-year and 15.2% sequentially. That was expected given the well-known alternative data that’s out there. The decline was driven by industry units being down about 12% sequentially—the ongoing impact of high used car prices and high auto loan rates on vehicle affordability—on top of Carvana’s self-imposed profitability initiatives, which include dramatically reducing inventory, which hurts selection and therefore sales conversion, slashing advertising spending, and generally prioritizing the most profitable sales at the expense of less profitable or unprofitable sales. Being only 320 bps worse than the industry on a sequential basis despite these self-imposed headwinds actually seems not terrible.
The company cut quarterly cash SG&A excluding restructuring expense, now renamed Non-GAAP SG&A, by another $60 million sequentially. I would have rather seen $70 million, but $60 million was more or less what I expected. This has now declined by $137 million in three quarters between 1Q22 and 4Q22 with more expected to come.
The biggest surprise was a much bigger sequential decline in cash GPU, now renamed Non-GAAP GPU, which fell from $3,870 to $2,667.
Virtually all of that shortfall is explained by two non-recurring items. First, Carvana’s large excess inventory coupled with the deflationary environment caused unusually large retail and wholesale vehicle write-downs. That accounted for $701 of the $1,203 sequential decline in Non-GAAP GPU. Second, a large block of loan sales to Ally was pushed from 4Q into 1Q due to the imminent renewal of the forward flow agreement in January, which reduced Other GPU by $483. Excluding these unusual factors, 4Q non-GAAP GPU would have been closer to $3,751. I had previously guessed it would be $3,700. So overall, the quarter was as expected normalizing for the unusual and timing items in 4Q.
The stock initially declined 21% the day after the report, but has since recovered.
Three Steps
Management framed their mission in three steps. First, get to adjusted EBITDA breakeven. Second, get to substantially positive unit economics where adjusted EBITDA is meaningful. Third, start to turn growth back on likely by accelerating inventory buying and advertising again.
They are still clearly in step one, but as you’ll read below, I’m not sure it’s crazy that they could achieve step one later this year. If that’s right, then step two is probably a 2024 event. And step three probably begins towards the end of 2024 or in 2025.
Looking Forward to 1Q
On 1Q retail units, we know a few things.
Management said 1Q should see a sequential decline from 4Q’s 86,977 retail units.
They expect “weekly retail unit sales volume to stabilize relative to the retail unit sales declines we saw in the second half of 2022 as the seasonal headwinds we faced in the second half transition to seasonal tailwinds.” What does that mean? Well, weekly retail units declined 15.6% year-over-year on average during the second half. In 3Q and 4Q, the declines were -8.4% and -23.0%, respectively. In December the declines were over -30%. I’m going to assume this means they don’t expect 1Q and 2Q to be worse than -25% year-over-year. That would imply about 79,000 and 88,000 units, respectively. 2Q should get a seasonal bump of some size given the seasonality driven by tax refund season, although it will be more muted than prior years.
They also said the first seven weeks of 1Q averaged 5,600 retail units per week, which is a 24.7% year-over-year decline on average. March tends to be the start of tax refund season, but again, expect a more muted increase than usual due to Carvana’s profitability initiatives, including cutting back inventory and advertising. If the last six weeks of the quarter average ~6,633 units, they would hit the -25% year-over-year figure.
On retail and wholesale GPU, 1Q should have minimal, if any, write-downs given the inventory was marked at the lower of cost or net realizable value at 12/31/22. So I think we can add back $598 and $103 to Non-GAAP Retail GPU and Non-GAAP Wholesale GPU, respectively, which would suggest $1,230 of Non-GAAP Retail GPU and $655 of Non-GAAP Wholesale GPU, all else equal.
On Other GPU, the loan sales were pushed into 1Q, which should occur on top of loan sales that would have happened anyway, so Other GPU should see an unusually large increase. You can see the inflated backlog of loans held for sale here:
If Carvana sells ~79k retail units and loan originations are ~72% of used vehicle sales, which is…
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