Cars.com Inc. (CARS) Earnings Call Transcript & Summary

Good morning, good afternoon and good evening, everyone. Thanks a lot for joining the webcast. My name is Rajat Gupta. I'm a member of the U.S. automotive equity research team at JPMorgan. Very pleased to have with us Alex Vetter, CEO of Cars.com. On the format of today's discussion, Alex will be starting off with a couple of minutes of prepared remarks about the company, after which, we will dive into Q&A. [Operator Instructions] Or you could also e-mail the question to me or anyone from my team, and we'll make sure to ask the question. So with that, thanks, Alex, and I would like to hand it over to you.

Thanks for having me, and thanks for everybody tuning in today. Certainly, I think of all the industries that we could be talking about, automotive has got a lot of exciting things happening in it. This is the best retail environment that we've seen in over a decade, and COVID has accelerated rapidly the industry's adoption towards digital platforms. I think -- I hope everybody here knows the name Cars.com. We're the leading brand in the online automotive space. It's been tried and tested over 20 years. But I think what's important about this opportunity is our stock [Technical Difficulty] [ has been ] fully appreciated in the enormous transformation that's happened in the business over the last few years. We were a legacy company trapped inside media companies. And we were able to break the company out of its legacy ownership and spin it out into a new form. And the transformation has largely been successful across all of the various pieces that we've changed. We've made strategic acquisitions that are now growing at fast double-digit rates. And our core marketplace is now the fastest growing in the category. And so we're really excited primarily also because our strategy is differentiated. We've made a deliberate shift towards being an enabler for the auto industry. Our digital solutions strategy is rapidly growing, both with OEMs and with dealerships. And we've made some major migrations in our technology towards the cloud. That's accelerating the pace of innovation. You probably see this in our growth in both customer count and in pricing despite some pretty surreal trends in the broader industry. So happy to be here, Rajat, and just -- we'll turn it over to you to guide this conversation.

Great. Thanks for that intro. I just wanted to start off with more like a consumer-centric question. Given your platform is consumer-centric, you seem to have great visibility on underlying demand trends. Can you give us an update on just the general health of consumer demand, dealer inventory levels? Maybe in context of levels we've seen in the second quarter and first quarter and also in context of the record pricing we have seen recently and if that is starting to have any impact. General Motors made a comment on one of their earnings calls recently that they want to be careful with pricing. And there's like an upper limit ultimately in how high it could go. So any thoughts on that to start off will be super helpful.

Well, a couple of opening comments, and we can dig deeper on any one of them. So inventory shortages are real, but they do vary by market and by manufacturer. And I think this is one of the reasons why our platform has stood up so well during this supply crunch in that -- platforms like Cars break down geographic and physical barriers. If you're looking for a specific car, you can search nationwide and find who has the car you're looking for. So I know both manufacturers and dealers are realizing that even if they have lower inventories, they still need to have their inventory that they've got to be found. We are seeing differences between domestic and imports. So Ford, it's been well documented, it's been extremely impacted by the production challenges. The F series trucks have been the #1 selling vehicle every month since before 2011 but now is #3 in May and June and has felt some of the largest declines largely due to inventory shortages. But consumer demand is persistent and is outpacing supply. So if you look at our platform, which is a pretty good summation of what's happening out there, new car inventory levels are down about 35% on our platform in Q1, and now it's down close to 65% as we're entering in the tail end of the year. And used car inventories are also down almost 20% in Q1. We're seeing that slow down, and only down about 12% in the recent period. But the consumer story is real, right? Our demand and our consumer traffic is up almost 10%. And I think underlying that to the health of the market, prices for inventory are actually rising. New car prices are up 17% since start of the year and used car prices reached the high-water mark of up almost 30%. So what this is leading to is record profitability. You're seeing this in all the publics. They're reporting it across the industry and gross profit per vehicle up substantially. I know Carvana reported their first quarterly profit. And so the industry is in a really healthy spot right now.

Got it. So it doesn't seem like pricing is having any -- pricing has not gotten to a level where it's starting to really sway customers away in terms of like -- in terms of just demand. And it just seems to be pretty healthy despite that. Is that fair or...

I do think you're going to see some used car pricing softening. I mean one of the big trends, obviously, over the last year is the rental car companies. If any of you have traveled recently, you know what I'm talking about. They haven't had any supply. They've been buying used cars, trying to replenish fleets that they liquidated this time last year. So I think with schools opening back up and families going back to school, you're going to see less travel. And so the rental car companies are going to pull back in their buying patterns, which is naturally going to soften the used car market, that's just my own personal prediction, but I think we'll see some softening of that. But I think the consumer demand due to COVID is real in terms of consumers want to have the latest and greatest technology in the garage. They want to have safe, reliable transportation.

Got it. Got it. That's really helpful anecdote. I wanted to switch gears quickly to online and digital retailing. As you've seen, as you've heard, dealers are increasingly expanding their solutions, their own platforms just as consumers' appetite for online purchases have grown through the pandemic. Any metrics you could provide on the penetration or adoption of your digital solutions? And just kind of like what do you have in terms of offering pipeline or product pipeline that can further enhance this and make it easier for both the consumer and the dealer to transact through your channel?

Yes. Well, look, I think a couple of answers here: Number one, this industry shift towards digital channel experiences, we've led it with our acquisition of Dealer Inspire. Dealer Inspire had less than 1,000 dealers when we bought the business. We're reaching close to 5,000 dealerships. We're powering their primary website, including the e-commerce experiences for some of the largest publicly traded groups. So we're helping make the industry shift towards this digital-first platform. I'd like to say our strategies -- we're really about arming the rebels, right? We're giving them the tools and technologies so that they can compete locally. I think what's really exciting about our other business, our marketplace business is that we're really about pretail versus retail, meaning that every consumer does heavy amounts of online research prior to purchase. And if you think about our platform, we've got 25 million people actively searching for the car and the dealership they want to do business with prior to launching into a retail transaction experience. And so our marketplace aggregates demand. Our solution strategy helps dealers convert that. And what we see in the data to me is very exciting with in terms of our future prospects. I mean we've got decent SaaS-like revenue with our subscription model, charging dealers around $2,000-and-change per month. But now that we can see vividly the transition of users from our marketplace into our digital solutions, what we're seeing in the data is that Cars.com shoppers are converting at twice the rate of all other traffic sources combined. And most of our marketplace is valued on lead gen, which is first-generation advertising. I think second-generation and third-generation, where we're going, is really helping get that consumer journey from a market-wide view into a digital experience and helping dealers convert that traffic to sales. I think this is why all the big publicly traded groups list their cars on Cars.com. They see this being digital only. They know how well our traffic converts. And now we've got to convert for the long tail of the industry to see what the big guys do.

Got it. And just to follow up on that, TrueCar talked about this, they're piloting this end-to-end solution where consumers can do like an end-to-end transaction through them. And clearly, like -- it seems like that's what consumers are looking at in terms of like experience. Carvana provides like an end-to-end experience. And there have been a lot of talk about Carvana listing third-party inventory and helping -- and providing an end-to-end transaction for that car, which is located at another dealer. How are -- what's your -- what are your own issues on that front like? Do we see you going towards that kind of like an end-to-end solution for the consumer and just to provide that kind of experience, integrating the financing, the delivery, the trade in? Like just managing that for the dealer, is that like the path you think -- or is that like how the industry models may look like in terms of your participation in the supply chain?

Okay. There's a lot to unpack there. Let me try to break it down in some pieces. First of all, I think the word e-commerce and automotive is overblown. I mean at the end of the day, this is one of the largest physical goods that has to be delivered or picked up. And so it's not like it's going to arrive in a brown Amazon box at your door. I think what I'm excited about is how many dealers are now offering home delivery. So we were the first to launch this nationally. We've got over 10,000 dealers now that are willing to drive a car to bring it to your home for both a test drive or as part of a purchase. Dealerships are ramping up their BDCs, which -- their business development centers to handle online transactions just like Carvana. And so the entire industry is starting to claim high ground in terms of this new online experience. And we're excited because we're helping the industry adopt it. I think, again, what's exciting about this is all these players trying to fight for transactions, the best way they can do that is to source shoppers who are in the research funnel and phase of the game. And that's where we aggregate demand. And so average user on our platform is spending a significant amount of time, north of 40 minutes prior to launching into a retail environment. And so as we aggregate demand, that's how we've got 19,000 dealers and growing plugging into our system. So I think our business is well positioned to help the industry shift. And we haven't even seen the OEMs, who are now ramping up their omnichannel experiences as well. And we're excited about what that can mean for our business as well.

Got it. Just one last point on like the online solution. We've seen these acquisitions from like -- just all of a sudden like last 3 or 4 months. We've seen like Roadster get acquired by CDK, Gubagoo by Reynolds and Reynolds. I don't know if I mixed that up. But the Darwin -- and I've been hearing about AutoFi -- and so just curious as to like why is this happening now? What's the power of these acquisitions? Like how does that help the industry accelerate towards e-commerce? And where do you fit within this landscape then?

Well, look, I think -- as I said in the opening, I think what COVID has done is it's made the entire industry radically shift their strategy towards technologies and digital solutions, which has been our strategy all along. And that's why you're seeing acceleration in both dealer count and average revenue per dealer. And we see that those trends continuing to scale. I think this is a big TAM opportunity. So there's no shortage of new technologies and tools to compete. I think we're excited about the opportunity to plug in new technologies into our existing distribution. I mean it's a highly fragmented industry. There aren't many platforms that aggregate both consumer demand or dealer participation. We're one of the leaders in both. And so as we look at our capital allocation, it's easy for us to identify technologies that the industry wants and plug it into our existing distribution. I think you're seeing this with FUEL, which is our digital video platform. We know that you don't need a television station anymore to broadcast. Digital channels have taken over the airwaves, yet dealers in the auto industry are spending $10 billion in linear TV, broadcasting to the mass market. With FUEL, we actually allow the industry to narrowcast just to the percentage of the population that's in market. And it's the fastest-growing product in our set because we've already got distribution built with dealers. We've already got strong consumer demand. We've built FUEL and distributed it. And I think you're going to see more opportunities like that from us in the future as we put our capital to work.

Got it. Got it. That's helpful color. And just to follow up on your previous comments, where you ended by talking about the OEMs moving to omnichannel. Ford talked about their order bank model on their earnings call recently. And as dealers carry significantly lower inventory, there's talk about like this agency model that might come into play in the U.S. similar to like what we have [ already ] in Europe. So what do you think is going to be the new normal for the industry structure going forward as these OEMs start to deploy this reservation system? Like how is the dealer relationship going to look like? And how do you -- what kind of role do you see yourselves playing there?

Well, look, I think the nonnegotiable durable trend in the auto industry is research prior to purchase. Next to buying a home, this is the second-biggest ticket item in everybody's lives to buy. So to think that you're going to build one e-commerce experience and everybody is just going to go there and buy without doing any research, that's a fool's errand. I mean we've been around for 20 years and yet have no problem aggregating 25 million car shoppers every month. 75% of our traffic is coming to us organically or directly. We don't have to spend ungodly amounts of SEM to build our traffic. It's coming to us naturally and organically. And if you look at what happened in COVID, even when we cut our marketing budget in half, our traffic numbers surged because this is better consumer experience. You don't want to buy a car going through one channel. You want to see a market-wide view and that's what we've always been. I think as the funnel gets smarter digitally, OEMs and dealers are seeing what I've known all along is that, that research traffic converts at the fastest and best rate. There are handraisers that are actively in the market. And so I'm thrilled that the OEMs are now studying Google Analytics better. I'm thrilled that dealers are hiring people to help them analyze these traffic trends. What we see vividly through our Dealer Inspire back end of 5,000 websites is that Cars.com traffic converts higher and generates more volume than all our peers. And so I think that we've got a very durable marketplace business. Marketplaces tend to be the dominant use case for mass market users. I think that's why you're seeing dealer participation. I think our solution strategy helps the vast majority of our industry advance towards digital retail. We've got all the tools to do that. And so I think our business is well positioned to both ride the growth in digital spending and ride the growth in solution spending that everybody is going to be adopting over these next few years.

Got it. Great. One thing we have seen over the last quarter, particularly in the second quarter relative to the first quarter and maybe prepandemic, that dealers are becoming increasingly focused on retail sourcing, like sourcing cars directly from consumers. Just -- it makes sense, higher margins, less wholesale fees and wholesale pricing itself has been so volatile. So on this front, one of your peers recently launched an online appraisal tool, helping dealers ramp up customer sourcing, [ buy and sell ] transactions. So could you -- can you share your views on this pivot towards consumer sourcing? And how are you participating in that? How are you helping dealers? Could we see you launch like a major offering in that direction? Maybe you're already doing so and it's probably not been appreciated yet. Any thoughts on that would be helpful.