Carvana Co.

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 2/5

Carvana is an online used car retailer that allows users to buy, sell, or trade in vehicles with a focus on convenience and technology.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview Carvana Co. operates as an online-only retailer of used vehicles, offering a completely digital car buying experience to consumers. This experience includes the ability to browse inventory, secure financing, obtain trade-in values, and arrange for delivery or pick-up, all through their website or mobile app. Carvana has disrupted the traditional used car industry by emphasizing convenience, transparency, and a fully online experience.

Revenue Sources: Carvana’s revenue primarily comes from the retail sale of used vehicles. They also generate revenue from vehicle financing, extended warranties and service contracts, and sales of wholesale vehicles.
Industry Trends: The used car market is massive but heavily fragmented. The shift towards online retail and the desire for convenience, fueled by technology, has become the major trend. These trends can put pressure on legacy business models.
Margins: Carvana struggles to make consistent profit. Gross profit margins can be good but operating margins are negative and not even close to breakeven. This is because of interest expenses, SG&A, and other expenses which the company has struggled to manage.
Competitive Landscape: Carvana faces competition from traditional used car dealerships, online car retailers like Vroom, CarMax (which also offers an online-purchase model), and even private sellers through platforms like Craigslist, Facebook Marketplace, and online car classifieds.
Differentiation: Carvana’s differentiators are its fully online and convenient sales process, its “car vending machines,” and its relatively transparent pricing and inventory.

Financial Analysis Carvana is currently in a state of financial distress with high debt and low revenue, and operating metrics are also not improving.

The latest 10-Q shows that Carvana recorded a net loss of $283 million for the three months ended September 30, 2022, vs $74 million in profit in previous year.
For the nine months ended September 30, 2022, Carvana had a total revenue of $10.7 billion but a net loss of $2.76 billion.
The company’s balance sheet shows total assets of $11.1 billion against a total liability of $11.28 billion and total equity (or negative equity) of $-176 million. The short-term debts that need to be paid within a year are $1.46 billion, compared with only $287 million in cash and cash equivalents.
Free cash flow over the 9 months ended September 2022 was a negative $-2.44 billion, reflecting ongoing cash burn.

Moat Analysis: 2 / 5 Carvana’s “moat”, the competitive advantage they have over rivals is extremely weak.

Brand recognition: Although Carvana has created some brand recognition, this is not as strong as traditional incumbents or other online retailers. It will be difficult for them to build trust with consumers.
Switching costs: There is very little switching costs for buying cars from other sellers, since it does not cost a customer to buy from others. Consumers are willing to shop around for the best offer.
Cost advantage: Carvana has no discernible cost advantage. Due to its expansion, they have high operating costs and huge debt. Since most cars are the same, the company has no proprietary method of production, leading to heavy competition on prices.
Network effect: The company cannot really benefit from network effect because cars are physical products with independent utility. Although the platform tries to create a network, this does not stop other businesses from easily creating their own.

Legitimate Risks and Business Resilience

Competition: The used car market is extremely competitive, and Carvana faces threats from larger and better-funded rivals.
Economic Sensitivity: Carvana is especially vulnerable to economic fluctuations since during downturns consumers often postpone car purchases or seek cheaper alternatives.

Debt: The company has taken on a significant amount of debt to grow rapidly, and with high interest rates, it will be difficult to become profitable. The company’s massive debt creates a huge risk to its longevity.
Profitability: Carvana’s inability to produce profit has always been a major concern. All the growth in revenue hasn’t translated into profit and the company’s future is questionable.
Operational Challenges: There are several indications that suggest that Carvana has issues with the delivery, inspection and overall operations. This further erodes its brand perception and trust with the consumers.
Technological Innovation: Although technology has helped Carvana a lot, the company’s technology can be easily replicated, meaning that the company’s advantage here can fade quickly.
Recent Controversies: Carvana was reprimanded and put on probation by Illinois regulators in late 2022, for title-related and other issues. More recently the company also reported that some of its cars were involved in safety recalls and that their finance arm can be a possible risk factor.
Management Outlook: In its latest earnings call, management has said that the near-term revenue and growth will be muted, and have also stated that they don’t expect any recovery anytime soon.

Understandability: 3 / 5 The business model is fairly easy to understand as they are primarily a retailer.

The company purchases used cars at low prices, marks them up, and sells at higher prices.
The company provides financing as well, further adding revenue and complexity.
The company has operations within the United States, but with the logistics and scale, it does become a bit more difficult to understand and analyse.

Balance Sheet Health: 2 / 5 Carvana’s balance sheet is currently in a very bad shape due to the massive amounts of debt it has.

A low cash balance and high amount of short term debts are indicators of financial distress.
The fact that they are running with negative equity is also not a positive sign.
While they do have a lot of assets, most of it is non-operating and very difficult to liquidate.

Conclusion Carvana’s business model has disrupted the used car market with its focus on convenience and technology. However, the company’s lack of profitability, increasing debt, poor management execution, and weak moat makes its future uncertain. For an investor, the company presents a lot of risks and is not very attractive for conservative investors.