Carvana Co (CVNA -0.68%) is a fast-growing e-commerce platform for buying and selling used cars. Listed in 2017, it has had a good run, with revenue more than quadrupling between 2017 and 2019. Despite its solid performance, Carvana is still a very young company with huge growth potential that could last for the next five to ten years.
Source: Getty Image
Compelling business model
Carvana operates an integrated e-commerce platform that covers every aspect of used car retailing, including online sales, financing, logistics, inspection and repair centers, software development, and more. This end-to-end business model disrupts traditional used car sales in several crucial ways.
Customer-centric operations
One of the most important aspects of Carvana's business model is its intense focus on delighting its customers by providing the best user experience, selection, and value.
Traditionally, shopping for a used car from the local dealership is largely unpleasant, tedious, and time-consuming. Prospective buyers must search for a car in the showroom, negotiate with trained salespeople, and fill out reams of paperwork -- a process that can take days, with no assurance that shoppers will leave with a car they want (and can afford).
Carvana aims to change this. Its integrated online sales model allows customers to conduct the whole buying process from the comfort of their home: selecting and viewing their favorite car, arranging for financing, trading in their existing car, and receiving their new one -- Carvana will deliver the new car and collect the old car using its branded car hauler. Customers in certain markets can also choose to pick up their vehicles at one of its car vending machines -- these are multi-story glass towers that
Carvana uses to store vehicles.The company also offers its customers a seven-day return and 100-day warranty policy for every purchase, reassuring shoppers that they can buy online without getting cheated.
Moreover, Carvana's nationally pooled inventory of 33,500 cars provides a wide selection of options for customers to choose from, increasing the odds that customers can find their ideal car. In contrast, traditional dealerships usually offer a limited selection, because they typically optimize inventory holdings at each dealership location, even if they offer many more vehicles across multiple locations. Hence, buyers usually have little choice but to drive to a few dealerships across multiple locations to search for a car, which is a frustrating experience.
Also, Carvana's integrated, online-only model, run by its proprietary technology means that it has a lower operating cost -- it requires minimal physical presence and hence saves money on expenses such as rent and salary -- as compared to traditional brick-and-mortar dealerships. Besides, its pooled inventory approach will likely result in less time it needs to sell a car -- the longer a car remains unsold, the more it will lose its value due to depreciation charge -- which further reduces its cost structure. These savings can then be passed on to customers through lower sales prices.
Though the company's still in its early days, there are signs that Carvana's customer-centric approach is working, evident by its performance metrics:
- Used-car sales volume surged from 6,500 in 2015 to 177,500 in 2019.
- Customers rated the company an average of 4.7 out of 5.0 based on over 45,000 satisfaction surveys, from the company's inception through Dec. 31, 2019.
- Gross profit per unit jumped from $206 in 2015 to $2,852 in 2019 thanks to factors such as an increase in car purchases directly from customers -- which cost less as opposed to buying from auction --, lower average days to sale, and higher complementary services sold. .
Highly scalable model
Another thing to like about Carvana's business is its capital-light nature. Traditionally, a brick-and-mortar car retailer has to invest in fixed assets -- which can cost up to $22 million per dealership -- and additional working capital to pay for operating expenses.
In comparison, Carvana needs very little initial capital when entering a new market since there's no need to separately invest in new local inventory, or spend much on operating expenses -- normally, it will cost the company about $0.5 million to buy one or two delivery trucks, a multi-car hauler and some furniture and fittings. It will also need to spend some money hiring a team of customer advocates and initiating local advertising. As a market scales, Carvana may then choose to invest in a car vending machine --which cost about $5 million --to improve the fulfillment and further increase customer awareness.
Its capital- and labor-light model, thus, allows the company to rapidly expand its market reach. Starting from a single market in Atlanta, Georgia in 2013, it has now expanded into 161 markets as of the first quarter of 2020 -- covering about 66.9% of the total US population.
Despite its rapid expansion, Carvana accounts for less than 1% of the secondhand car sales market -- which is estimated at $764 billion, with the top dealer and top 100 used-car retailers accounting for 1.8%, and 8.6%, respectively, of the total market share.
Hence, with its capital-light and scalable business model, Carvana is well-positioned to rapidly expand its business over the next few years.
Risks that investors should know
Despite all the positive factors mentioned above, investors should carefully watch several key risks for this young company.
Continuous losses
One of the major risks is that Carvana is still a loss-making business and will likely remain so in the foreseeable future. From 2017 to 2019, net loss more than doubled from $164 million to $365 million owing to the company's continuous investment to expand its business.
Since the company is still in a very early stage of development, there's no guarantee that it will achieve the necessary scale to breakeven on its business operation, let alone be profitable.
Fortunately, there are signs that it is progressing toward profitability -- gross profit margin has improved from 5.3% in 2015 to 12.9% in 2019 while net loss margin has declined from 25.5% to 16.7% over the same period.
Lots of competition
Carvana operates in a highly competitive industry with major competitors, including major dealerships like CarMax, Inc (KMX 3.55%) and AutoNation, Inc. (AN -0.08%), online car sellers such as Shift and Vroom, as well as other independent dealerships across the country. Besides, there's a possibility that internet players like Amazon.com, Inc. (AMZN 0.01%) may decide to join the party someday.
Many of these companies have a longer track record, financial resources, and operational know-how, which may post a significant threat to Carvana's long-term growth. Still, Carvana's integrated online business model has some advantages over these players -- for example, Carvana can sell to customers in smaller markets which these players have no presence, mainly because these markets are too small to justify the investment in independent stores. Moreover, the US used car market is massive (see above) and should have enough room for multiple players. Moreover, Carvana's online model has some advantages over these players --
Watchlist stock
Since its IPO in 2017, Carvana's stock has shot up by more than 500 % thanks to its solid revenue growth -- annualized at 114%--and the positive market sentiment. This puts Carvana's valuation at a high level of more 3.5 times sales . Comparatively, Carmax's stock is currently trading at a valuation of below one times sales.
On one hand, investors might argue that Carvana deserves to trade a premium valuation considering all the positive factors mentioned above. Yet, buying at today's price offers investors a low margin of safety, especially considering that the business is still loss-making. On balance, I think investors should play it safe and keep the stock on their watchlist until its valuation becomes more attractive.
