I looked into Carvana, again, and I am surprised by the way the management is communicating key information.
Disclaimer: I have no exposure to Carvana, and never had.
The post will be divided into the following segments:
- Misleading investors
- Painting a rosy picture with window dressing
- The trouble ahead
Misleading investors
As Carvana is an eCommerce platform for buying/selling used cars, the revenue, as well as, the gross profit per unit are both important to keep track of.
The company has 3 different revenue sources:
- Retail Sales
- Wholesale Sales
- Other (Sales of financing loans and commissions)
I'd like to point to the Gross profit per unit (“GPU”). It doesn't take a high level of education to calculate this, right?
Here are the numbers from the last quarter:
- Gross profit: $499 million
- Retail vehicle unit sales: 76,530
- Wholesale vehicle unit sales: 46,453
If you did the math correctly, you'd get slightly above $4k gross profit per unit.
Carvana reports a GPU of $6,520. You might wonder how? Where does it go wrong? Well, the explanation is simple. They divide the total gross profit with only the retail vehicle unit sales.
This makes absolutely no sense! Not only that, it is being communicated everywhere.
Painting a rosy picture with window dressing
It is not uncommon for companies to use accounting tricks to show somewhat better results. I'd like to point to Carvana's free cash flow for the first half of 2023. Based on the cash flow statement,
Cash from operations $443 million
Capex: $50 million
Free cash flow $393 million
This is not bad for a company that is not profitable, so one might wonder how can this be the case.
No, the explanation does not lie in share-based compensation.
Let's take a look at a simple example – A lemonade stand:
Imagine you own a lemonade stand and on the 31st of December 2022, you’ve spent $1,000 to buy all the raw materials needed (lemons, sugar, etc.)Then, in the new year, you’ve sold all of this for $950. Yes, you lost money as the business is not profitable. However, during 2023, you brought in $950 in cash from operations!
Now you have a lemonade stand with no inventories, as you did not buy more lemons and sugar. This is clearly not sustainable. If you did restock and spent $1,000 again, the cash from operations would have been -$50 (matching the profitability of the business).
Let's go back to Carvana. During these 6 months, Carvana reduced its inventory by $564 million. So, the company now holds less inventory than it had before. All companies of this kind, need to restock. Therefore, if Carvana restocked, the free cash flow would have been negative $171 million.I think credit should be given for reducing inventory, but the $393 million of reported free cash flow should not be used as a guide for the future.
The trouble ahead
The most common method of buying a car is using a car loan (based on Statista, 84% of the cars in the US are financed). That means the total cost of the car is the sum of:
- The purchase price of the car, and;
- The interest on a car loan
With rising interest rates, there are two scenarios that could happen:
Scenario 1: The prices of the cars remain the same, leading to higher total costs, which will lead to lower demand
Scenario 2: The prices of the cars will drop due to the lower demand, which will lead to similar total costs. From an economic point of view, it is likely to experience scenario 1, followed by scenario 2.
In both scenarios, Carvana is exposed to a tough environment.
The company is still unprofitable, it has $8.5 billion in debt (including leases), and roughly $0.5 billion in cash. In my opinion, regardless of the refinancing, the company is headed for bankruptcy. Could I be wrong? Of course.
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