Carvana Co. (CVNA) Earnings Call Transcript & Summary

Great. We've arrived and before we jump in just, today's discussion may include forward-looking statements within the meaning of the federal securities laws, which are subject risks and uncertainties that may cause actual results to differ materially from such statements, detailed discussion and the materials factors that may cause actual results to differ from forward-looking statements can be found in the Risk Factors section. Carvana's most recent 10-K and 10-Q filed with the SEC. Forward-looking statements and risks in this presentation are based on current expectations as of today and Carvana assumes no obligation to update or revise them, whether as a result of new developments or otherwise.

All right. So thanks, Mike. So good morning, everybody. This is Stephen Ju from the Crédit Suisse Internet Equity Research team. We are very pleased to have joining us Ernie Garcia, the CEO of Carvana. So welcome back, Ernie, and thank you for joining us today.

Thank you. Glad to be here.

All right. Awesome. So for those who are not as familiar with Carvana, I was wondering if you can just give us an overview of the business model, the value proposition and how you view the opportunity in the used car market.

Sure. Let's start with -- let's zoom in the reverse order maybe. So the used car market is huge. It's about 40 million transactions per year. Depending on what data sources you're looking at, you've got a market that's on the order of $1 trillion in size. It's a really, really large market. It's massively fragmented. I believe when we went public, the top 100 players in the market had about 7% market share combined. I think now that's more like 8%, 9%, or 10%. I can't remember exactly what the number is, but it's got a little bit more or a little less fragmented, but it remains incredibly fragmented. The value prop, I think, is -- and the reason I want to start with that instead of describing the models because I think that, that's what drives everything that we do. So I think when you look at the traditional experience of buying a car, some dealers do a great job, giving customers a good experience, but a lot of kind of what we culturally think of when we think of buying a car is not super positive. People, generally speaking, don't get great experience. And I think there's a lot of deep kind of fundamental economic reasons that underlie that. And so when we set out to build Carvana, our goal was to build a better experience for customers, and I think we define a better experience by thinking about what we think matters most to customers. And so that's building a business model that gives them a broad selection, a fair price, a great experience and confidence they're getting a high-quality car. And so that's what drives everything that we do and kind of every design choice we make on the website or in the broader business model is aimed at trying to make sure that we're satisfying those underlying goals. And then our business model is we're vertically integrated automotive retailers. So we buy cars from consumers from auction, from rental fleets from captive finance companies, from every source where you could buy them. We then ship them to our reconditioning centers. We put about $1,000 of parts in labor in each of those cars. We have our own first-party logistics network where we can ship those cars out to customers. We have a fully transactional website. Customers can go onto that website. They can search nearly 30,000 cars today. They can spin them in 360 degrees with our proprietary software to get a sense of what the car is all about. They can go through and get kind of a bid for their trade in they can get approved for and select the financing. They can sign contracts. They can schedule the delivery, and then we'll deliver the car to them as soon as the next day. And then that's all supported as well by what we call our inside advocates that answer any questions the customers have over the phone or over chat or text. So that's the business model. And then we've been rapidly growing. Since we launched in 2013 through 2019, every year we had triple-digit revenue growth. Obviously, 2020 has been an interesting year to say the least, but we're continuing to grow very fast despite all of that. And we are still extremely small compared to the opportunity. I think, depending on what data sources you're looking at, for total used car market volume in the third quarter, we are probably something like 0.6% of the entire market. So we're still very small compared to what we can be.

Got you. I mean, it always starts out with kind of fix a broken consumer experience and taking on the friction, right? So what does the future look like in 10 years? And how does Carvana play into that future?

So I mean I think -- we don't think customer preferences are going to change in a material way over 10 years. And so I think the question is how well can you serve those preferences? How scalable is the solution that you build? How quickly can you evolve to continue some of those preferences better than everyone else? And then depending on what sorts of investments are necessary to serve those preferences and build a scalable offering, how concentrated might the industry be in a world where the underlying investment necessary to build the customer experience that is desired is significantly higher. And so directionally, we think that we're in a leadership position, and we think that we have built a lot of things that are really, really hard to replicate that do deliver an exceptional customer experience and that they're very scalable. And so I wouldn't want to get to quantifying everything specifically in 10 years, but I think we're going to try to run as fast as we possibly can. And we think that we're in a huge market that probably in light of the new way that things are being done should be less fragmented than it is. And so that suggests a whole lot of opportunity in our eyes.

Got you. I think you touched on 40-plus million used vehicle transactions that take place every year. But given the characteristics of the vehicle sold at retail at Carvana, what do you see as your addressable market? And to tap on to that, there has to be certain vehicle qualifications for retail sale, in terms of age, quality, price range, et cetera. And how might that be changing over time?

So there's a lot there. I think we use $40 million because it doesn't force us to make choices. And I think that, that's just kind of the sum of the entire market and then you can kind of decide how you want to call that from there. And you could call in customer demographics, you could call in vehicle specifications. I think the offering that we're trying to provide, which is a broader selection, lower price, better experience, more confidence, that is independent of customer attributes or vehicle specifications. And so I think over time as we continue to build out our brand and the behavior of buying cars this way normalizes, and we kind of get more inspection centers and have the capacity to take on older cars. We expect for what we're covering to continue to broaden. And that said, I believe, roughly speaking, this number may not be exactly right, but it's approximately right. I think about 50% of cars that are sold -- used cars that are sold are less than 5 years old. And then I think once you get to 9 years old, it's something like 70% or 80%. So you've got kind of the bulk of car sales are happening in the relatively newer, clearly, more addressable part of the market. I also think it's interesting to know when you're thinking about kind of market size, it's not clear $40 million is, in any way, shape or form the ceiling. $40 million is kind of the output of the equation of 270 million cars on the road and people swapping cars every 6.5 years. People don't consume cars. You don't consume a car from start to finish. You consume miles on the car that you're driving. And so the most important thing to think about there is like that 6.5 years is the thing that defines how large that market is. And that 6.5 years is kind of driven by the underlying cost to transact the -- experience frictions to transact, the cash frictions to transact. And so I do think that there's opportunity for that market, independent of population growth to potentially grow maybe significantly. And then beyond all that, I would also just point to -- we're currently 0.6% of the market. So I think when you're looking at what our future holds, by far and away, the biggest driver of kind of how big we can be and how big of a company we can build is the market share that you believe that we can ultimately attain. That's clearly going to be the most important thing because I think reasonable people could probably have expectations there that could vary by maybe an order of magnitude from top to bottom. And I think that there's not an order of magnitude of variation in the way that you would describe the size of the market or the way that you think about the unit economics of the opportunity. So I do think market share is, by far and away, the most important determinant of how big we can be.

Got you. And kind of rolled into that, what are some of the biggest opportunities for you to improve the Carvana experience for the consumers?

So I think that there are many opportunities. I'll put them in maybe 2 large buckets. So 1 bucket is just getting better at all the things that we currently do. I do think any time you build a business, you need to kind of ensure that you don't tackle so many things that you do, whatever you're doing poorly, but you also need to make sure you're tackling enough things where you're offering a complete customer experience. But any business, at least in my experience and any part of any business is you always kind of see like the top of the iceberg. And then once you kind of get into it, there's a lot more underneath the covers that you need to build to provide kind of the ultimate customer experience that you want to provide. And so I think in everything that we do we're very early on in terms of just making it as seamless as possible for our customers and just continuing to improve the experience. So I think there's still a lot of opportunity that will ultimately make our costs lower, that will make customer experiences better in just all the things that we already do. And then I think the other kind of very large bucket of opportunity, maybe there's going to be 2 other buckets of opportunities. So one of the other very large buckets of opportunity is just when a customer buys a car, there are many, many other things that they do simultaneously. So one that we're obviously very involved in is financing. They need to get financing to get a car. But there are many other things that fit a similar description. And so I think we have a lot of opportunity to continue to just deepen our relationship with the customers with respect to the things they need when they buy a car. And then I think the last opportunity for us is we've built a lot of really high-quality assets as we built out the business of Carvana. And I think that those assets generate for us, lots of other interesting opportunities. And I think we have to be thoughtful about which of those opportunities we pursue and which we don't. But I do think that there's a lot of other ways to tangentially use the assets that we've built.

Got you. Now indeed, it's been a crazy year for everybody. So what have you learned as you navigated the pandemic this year? And as a management team, as a company or in any other way that you choose to quantify, what adjustments do you think you will need to carry forward?

So I mean I think in like the grand scheme of the deep fundamentals, the pandemic doesn't change that much. It's obviously a huge theme right now that everyone's thinking about very deeply. But if we just kind of step back and say, what does the customer care about 10 years ago and 10 years from now? I do think it's the things that we listed earlier, and none of those things are specifically impacted by the pandemic. To me, the pandemic has -- it's created another consideration for customers, which is they would prefer not to be around as many people when they're doing anything. And so that's probably pushed people online. And I don't know how long that persists. It's probably not going to go away tomorrow. It's probably not going to last for 1,000 years either. I think that's one thing. And then the other kind of interesting thing I think the pandemic's done is because people have this new consideration, they've just tried new things and their behavior's changed. And I think a lot of times, habit is the biggest impediment to change. And so when you have just like a massive kind of lifestyle change forced upon you, you break many of your habits, you try different things and then you realize you like those different things. And so I think it can accelerate the adoption of change in general. So I think that those, to me, are the things that have happened with the pandemic, but I do think if you look forward 10 years, like, I'm not sure that we at least believe that our 10-year from now is materially different than what it would have been had the pandemic never occurred. To me, my -- the pandemic has been very difficult in so many ways for so many people. But my kind of favorite thing that I'll take away from it is just, I really do think our company really came together in that moment. I think that any moment of stress with any group of people kind of reveals where you really stand. You kind of see the best and the worst, I think, in people, in moments of difficulty. And I'm very proud of the way that the company came together and handled that. And I do think that inside the company, that's a universally held view, I don't -- I hope at least, that's not just my own view. And I think that, that has kind of strengthened the bonds between us. And I think that, that -- well, it doesn't fit in the financial model, that's a huge part of what matters. What matters to a company is there's so much time spent on like the attributes of describing the business. But so much of what really matters is kind of your vision for the future and your ability to evolve in the future and your ability to evolve in the future is a function of the people that you have and the culture that you have and the ways that you're tied together. And I really think that, that was strengthened going through all this.

I mean you touched on the cultural element. You're absolutely right. I mean there's no way, for us, outside looking in, to put that in the spreadsheet. But you are becoming an increasingly larger organization at this point, right? So how are we thinking about maintaining the culture and the customer experience? And how do you manage a technology organization at scale to be as efficient as you were in the past or even as you look for additional growth, even accelerate your pace of product development.

Sure. I think that, that is -- debatably, in my opinion, at least, the biggest and most important question. So I think the truth is size -- as you get bigger, just like a bigger group of people, further away in time from kind of your point of inception. I think there's just gravity toward mediocrity that, basically, you're constantly fighting. And I think that, that's something that every company is fighting. And I think that it's a hard thing to fight back and I think that history is full of kind of lots and lots of evidence that, that gravity exists. And I don't know that it's that full of that many companies that have done a great job fighting that gravity off. So I think that, that's a really, really important question is just how do we do a good job as we continue to get bigger, making sure that people care so much as they used to care, that we have the same culture, that we have the right sorts of structures internally that allow people to move independently, but also allow us to move cohesively. And I think that that's -- like we could spend 10 hours talking about that. And I don't know that we would get to any answers where you'd have 100% conviction because I just think it's a hard enough problem to where I'm not sure -- I'm not sure there's like enough -- there's many, many books that purport to have a solution to that problem. But if it were that easy, then everyone would just solve it, and I don't think it is that easy. So I think I really love the people we have and the company, the culture we have and then the awareness that we have of how important solving that problem is. And I think it's something that we put a lot of time and effort into. And I think we've gone through probably 4 or 5 paradigms going from a start-up of 7 people in the back of the room to where we are today, where as you kind of move through these different scales of company, I think the way that you need to maintain your culture and organize yourself is constantly changing. And I think that we've made the last several adjustments that we needed to pretty well, and I hope that will make the next several very well as well.

Got you. You touched on earlier how small Carvana is today versus the size of the opportunity in front of you. So how do you increase your pace of growth? I mean, if you want to think in terms of absolute units, that's fine, too. But how do you increase that pace of growth over time? And is there a limiting factor that you worry about?

I think it's -- I think execution is the limiting factor there. I think just given the size of the market, there's not a clear demand ceiling that we see anywhere in sight. I think we believe that the offering that we have is highly scalable. And I think there's lots of ways to think about what scalability means. But one way to think about it is just kind of like how much work does it take for us to grow to many, many X larger than we are today, relative to the growth that you -- the physical growth of operations and infrastructure that you've seen out of other companies and other retail verticals in the past. And I don't think that there's anything that suggests that we can't be very, very large when you think about it like that. Like they [indiscernible] is the logistics network has to be built out, and we need many more inspection centers. When you think about the inspection center being able to provide 40,000 to 65,000, 70,000 cars depending on the size of the inspection center that we're building. It just doesn't take that many of them to get to very, very large market share. And then the complexity of that operation is not materially different than other very large big box retail operations that have grown at hundreds of units per year over sustained in periods of time. So I don't think that there's anything deeply fundamentally limiting. I don't think there's any deep kind of labor limitations or anything else. I think it's a function of how ambitious we're going to be, how well we plan and how well we execute.

Yes. So in light of that opportunity in front of you, like, how are you prioritizing investments at Carvana? And how are you balancing growth versus profitability?

So I think that, that's a big question. I think the way that we try to think about growth versus profitability is sort of a function of how big is the opportunity in front of you versus the size that you currently are. If you've already maximized an opportunity, there's no growth left and so it gets very obvious what you should do, you should move all the way to profit. And if you're kind of 0 relative to an opportunity, then making profits on no units is useless. So I think the 2 corners are obvious. And then the question is just kind of where are you in between those 2 edges? And our view is we still remain very, very early in the game relative to the size. And so growth is absolutely our top priority, and we're working very hard to make sure that we're planning for that and that we're positioning ourselves well for that and we're maintaining the culture that's necessary to do that. So I think that's where our priorities are. Now despite our priorities there, I do think that we have a business that is fundamentally limited by the speed at which we can grow our operational capacity. And so I think despite the fact that over the last many years, since inception, 7.5 years, we focused on growth over profitability. We've made tremendous strides in profitability simultaneous with our focus on growth, such that we had our first EBITDA positive quarter last quarter, and we had 4,000 GPU last quarter. So I think that we've demonstrated that we can do both. But if we're picking, we pick growth.

Yes. So in light of everything that we've just discussed. And I mean, as you talked about, last quarter growth should remain your top priority. And given the positive feedback in the model, the argument to reinvest get stronger and stronger. So can you talk about what areas you had in mind for reinvesting into the business? And how aggressive are you going to be able to get in the business given the operational intensity that you just talked about?

Sure. There are so many areas to invest in the business. And so I think, by far and away, our view is the best place to invest is continuing to build out kind of the fundamental offering. So the technology stack and improving the logistics offering, every part of the business, the inspections that we're offering. We still just think there's a lot of room for deep improvement there. And that's kind of deep fundamental, highly differentiated improvement. So that's by far and away the best area for investment. You can only invest in those areas at a certain speed because it's driven by people, and you can't just throw dollars and have them constantly get a good return. Your amount of investment that you can make is a function of the quality of your management structures, the number of leaders you have inside the organization, the way that you're separating workflows and everything else. So I think that will be, by far and away, our biggest area of investment, but it's metered. And so it's something we have to constantly do is we have to think about what is our capacity to invest right now? And then we should pour as many dollars into that as we possibly can. We should also simultaneously be figuring out how, as an organization, we can have a higher capacity to be able to invest in our fundamental offering because we do think that there's just tons of opportunity there. And to me, that's about making sure that you're structured very well as you continue to get bigger. The other areas for investment would be marketing is obviously an obvious one. And then the customer offering itself, which could take many, many forms. Some of those forms are nondirect monetary, but they would show up as kind of a hit to our income statement. So it might be choosing to carry a larger inventory, which increases conversion and you're carrying kind of an inventory that is higher than our real-time optimum inventory. It may be carrying more inside advocates so that your service levels are very, very fast, even though that may not be real-time financially optimal. And then there are other things, obviously, customer-facing economics. There's vehicle price, interest rate, trade in value. There's all these different areas where you could invest as well. And so I think we just have to be very thoughtful about when we're looking through that stack of areas of possible investment, we have to decide how much investment is the right amount. When we're looking at our top area, which is product, we have to make sure that we invest as much as we responsibly can, but don't overinvest there and just throw money away because you don't have the structures in place to be able to get a return on that. And then when you're looking below that stack, you have to be thoughtful because as you invest in those areas, it's going to drive even more demand and you may not have the operational capacity to satisfy that demand. So you have to be investing in your operational chain to continually be able to satisfy that demand. And so that's the other obvious area of investment is all the inspection centers and logistics and just the infrastructure to enable greater scale.

Got you. You can't be growing this quickly without the industry taking notice of what you're doing. A number of other companies have come to the public markets this year. And some of the established players are also looking to replicate what you're doing. So what would you highlight as Carvana's biggest point of differentiation versus the other used auto e-commerce companies and probably the traditional players' efforts? And also, what is the biggest point of differentiation to the consumer?

So let's start with the consumer. I think it's the right place to start. So what does the consumer want? We've had this list and we've gone through a couple of times so far on this call. They want -- for them, it's selection for a shopper. There's maybe 2 kind of corner cases you can think up for consumers. Some are shoppers. They don't know what they want. And so they just want to see lots and lots of cars and lots of options. Then there's someone who knows exactly what they want. They kind of did their shopping, for lack of a better description, prior to coming to the website. And they're looking for a very specific thing. Both of those customers, though, the right answer to that equation, because you don't know exactly what this person wants, is to have lots of cars. So you need to have a broad selection so you're likely to have the car the customer's looking for. You need to be able to provide to them a price that is competitive and interesting and compels them to act now without the traditional force of kind of social pressure that would exist at a dealership. You need to be able to deliver the car to them very quickly. You need to be able to build a brand over time where the cars you deliver are in great shape. And you need able to build a brand over time where they know that if they buy a car and they don't want it, they can return it. So those are all things that, I think, matter. And then that all shows up in terms of just the brand that you build and what you mean to consumers, how they talk about you. But it's really, really hard to do all of those things. And I think oftentimes, it can get reduced to selling cars online, which I do think selling cars online is a big part of the tool set that enables the rest of the structures, the inspection centers and the logistics and customer advocates and everything to fit underneath. You kind of couldn't reach down into the supply chain and find those other fundamental savings if you didn't have this interface that didn't require the customer and the car to be in the same physical spot. So I do think it's a tremendously important part of the discussion, but it's kind of an unlocking mechanism for all the things underneath it that are real differentiation. And that's really important because as a retailer of a largely commoditized good, right, cars are -- there's definitely differentiation in cars. It's not the most commoditized of goods, but it's a more commoditized good. The only way that you can have a differentiated experience is you need to have a differentiated cost structure somewhere or a differentiated unit economics somewhere or you can't invest in the things that customers want. You can't carry extra inventory to give them the selection they want. You can't give them better price. You can't invest in the process that deliver a better, simpler experience. You can't afford to offer the return policy that gives them the confidence that they need. So you need be able to reach into those other things, you need to be able to find true differentiation. And so to me, that's what matters is, are you building the things that give the customer the experience that they want. But the things that they want are very, very simple and could be described in a very short conversation. And it can sound like the answer then is building the online interface for them. But I really do think the online interface, a checkout flow is not sufficient, right? If you exist inside of a market where there's 40,000 players and the differentiation is a checkout flow, like that's only going to last for so long until everyone builds that same check outflow and then you're going to be back to selling a commoditized product. So you need to build things that are hard and differentiated, that are less likely to be replicated. And then that's what provides kind of your ability to give a customer an offering that really is truly noticeably different to them. And then that gives you time to go invest and grow faster than anyone else while they're trying to catch up to there, and then you got to go find your next thing. And so I don't think it's just about the online checkout flow, and I think that it can get simplified to that. I also think that we should expect a lot more people coming our way over time. And we should expect a lot more people to start to figure those things out and start to reach in the supply chain and try to make the kinds of investments that we're going to try to make. And I think our future is a function of our ability to just keep running fast and delivering great experiences and stay in front of where we think we need to be to have a truly differentiated offering. But I do think it's a complicated thing. I don't think it's -- I don't think selling cars online is anywhere near sufficient.

Got you. We're coming up on time. So -- and I guess, so I would want to ask for more of a longer duration question. So if you look at some of the other e-commerce platforms that exist out there, they started out in one category, and then they expanded into the next thing and to capture incremental TAM. So how do you view the opportunity to expand Carvana beyond its current business today, whether that's moving in the direction of e-commerce platforms that we talk about that leveraged our assets or moving into adjacent markets or products?

So I think one of the great trade-offs, like you brought up profitability versus growth and I think that's one of the great trade-offs that we face. Another great trade-off that we will face is ambition versus focus. And focus is very, very valuable, especially when you have something that works very well and when you're very small relative to the size that you can be. There's a lot of kind of -- there's a very strong argument that you should stay as focused as possible and just go take ground and kind of taking ground will provide the fodder for you to be able to go do exciting things as well later. So I think that focus is very important. And I think we're at a place in our company history, and we're at a place in kind of the industry where, I think, we should be careful about letting our focus get to fray too widely. I also think that we're a very ambitious company. And we see all the opportunities around us, of which there are very, very many. I think the first thing you have to do when you're looking at those opportunity is you have to try to prioritize them and say, where are the biggest opportunities that feedback most positively on the core that we've got that require the least amount of incremental work and effort and therefore, risk that we kind of fall on our faces as we try to chase them down. And then you can kind of order them and then you have to decide how many you're going to tackle at any point in time. And I think that's a function of how you structured the company and how many great people you have inside the company and what your culture is and how comfortable you are giving autonomy to other people so they can go pursue these different things. And I think that gets back to the question that you asked earlier that I thought was a really good one about how do you structure yourself and continue to position yourself for increasing levels of growth as you become a bigger company. And I think that that's where like structuring yourself really intelligently is very important. So that ambition versus focus trade-off is another really big one, and we're going to be very purposeful about trying to get that right, but I think that, that's also a question that's complicated enough to where there's not a single answer.

Got you. And with that, Ernie, we are out of time. Thank you so much for joining us once again, and best of luck in the coming year.

Thank you. Appreciate it.