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Carvana: Game-Changer or Expensive Mistake?

- By Stepan Lavrouk

You would be forgiven for thinking that the used-car market is pretty impervious to disruption -- after all, haggling over the price of used vehicles is a centuries-old practice. Nonetheless, used car dealer Carvana (NYSE:CVNA) thinks it has found the magic ingredient to turn this industry upside down. Does it have what it takes?

The business model

Carvana's core value proposition is to eliminate the back-and-forth that takes place between buyers and sellers of used cars. In contrast to the existing used-car dealership model, where would-be purchasers haggle with dealers in person, when buying a car from Carvana much of the transaction is carried out online. Moreover, the cars are sold for fixed prices, which goes some way to eliminating the trepidation many people have about being fleeced by a dealer. The buyer can then choose to have the car delivered to their house, or can pick it up at one of Carvana's transparent "vending machine" towers, where the car will be lowered down to them.

Gimmicky marketing strategy aside, the business case here is quite straightforward: cut overheads by having the majority of the transaction take place online and reassure purchasers with a slick website and non-negotiable prices (the casual buyer generally prefers not to haggle).

Recent financials

Despite missing earnings estimates by 21 cents per share (on a GAAP basis; non-GAAP earnings per share missed by 5 cents per share), Carvana posted increased revenues in the first quarter of 2019: $775 million, beating expectations by almost $40 million and representing a year-on-year increase of 110%. The stock initially climbed when the results were posted, ending the day up 5%, but has since sold off 19% from that high. This could be a case of the market needing some time to digest the earnings report, or it could simply be a case of investors taking profits -- after all, the stock is up 65% year-on-year.

Margins still negative

Many short-side investors see issues with the stock, however. Carvana remains one of the most-shorted stocks on the New York Stock Exchange, with 40% of its float sold short (although that amounts to just 11% of shares outstanding, as only a quarter of its shares trade on the exchange). For one thing, margins continue to be negative. Management likes to point out that they have gotten less negative over time: 23% loss in 2016, 17% loss in 2017, 10% loss in 2018 and now a 7.4% loss in the first quarter of 2019.

Eagle-eyed readers will notice that although margins are indeed improving, the relative improvement is decreasing each period. Moreover, for a capital-intensive business like a used car dealer, margins are difficult to improve with scale. Add to this that it now has just $85 million in cash, versus a growing debt load (it took on more than $110 million in liabilities between the first quarter of 2019 and fourth quarter of 2018), and it is easy to see why short-sellers are targeting this stock.


Overall, this looks like a growth story that may be running out of steam. With mounting liabilities and still-negative margins, as well as a more risk-on sentiment generally speaking, it's difficult to see how investors would want to stick with Carvana. That said, many people had similar misgivings about the company all of last year, even as it posted impressive returns for shareholders. Nonetheless, this is one stock that does not look like a long play.

Disclosure: The author owns no stocks mentioned.

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This article first appeared on GuruFocus.