Carvana Co. (CVNA) Earnings Call Transcript & Summary

All right. So we have Carvana here. Really great to have -- we have Mark and Mike with us today. Thanks, guys, for joining us.

Thank you very much, Greg. Happy to be here.

Awesome. So I'm going to like run through some questions. I think we have some investor questions that we'll take as well. But first question I'm just going to throw out is Atlanta delivered 50% growth, despite being 9-plus years into life cycle. I think it was around 3.5 share. Can you quantify some of the puts and takes embedded in that cohort performance, whether it's logistics or logistic constraints or stimulus tailwinds, inventory availability, et cetera.

Sure. Yes, absolutely. So yes, I mean, I think we provided some data on our cohort market penetration in our ADESA acquisition deck, which showed our Atlanta cohort growing by a little over 50% per year to 3.5% market penetration. That's something we're obviously very excited about and we think points to big things in the future. I think some of the drivers of cohort penetration, I definitely think there have been puts and takes. I think compared to 2020, we were able to grow inventory year-over-year. I think that's definitely a benefit to conversion, other things being equal. On the other hand, we've talked about some of the dynamics that are playing out, both in the industry and in our business. In the industry, we've seen very significant used vehicle price inflation. The average car in our inventory is up about 30% year-over-year. More affordable cars are up even more than that. I think cars that were priced at below $15,000 in January 2021 have increased in price by -- on the order of 40%, while more expensive cars, say, over $35,000, have increased in prices only by 15% or so. So that's definitely, in our view, having an impact on affordability for the customer. I think our market cohorts cut right through that with significant growth in Q4. And so we're obviously excited about those patterns that we've seen.

Great. Next question is unit sales growth decelerated from 3Q levels. Can you just tell us what you're seeing in the current marketplace from a consumer demand perspective?

Sure. Yes. So we are seeing a number of things in our business today. I think still seeing very strong traffic to the site. We think there's a lot of demand. We do think affordability is impacting many customers' willingness to complete sales on cars at this time. But the other thing I would point to in our business is at various points in our company's history, we have faced various types of constraints, whether that be in our reconditioning centers or in our multicar logistics network. At times, it's been in our last-mile delivery network. At other times, it's been in customer service and transaction processing. And what we're experiencing right now is fairly acute constraints in our multicar logistics network. The origins of those constraints really started with Omicron. When Omicron hit, we saw big increases in call-out rates. Our logistics network functions as a chain system where there's multiple routes linked together. And so when you start to see elevated call-out rates, that has a meaningful impact on the functioning of the network. Omicron was followed by a series of severe weather events throughout the country. And all of those things have sort of accumulated a significant backlog in our logistics network that we are working to work through today. But I would say, from an operational capacity perspective, that's definitely the most acute thing that we're dealing with right now.

That makes sense. You also mentioned some softening in the lower income consumer due to affordability. I think we all see this looking at the gas pump and just how much that's risen as well as other inflation. And so just -- can you just elaborate a little bit on kind of what you're seeing there in terms of that lower income consumer and the affordability?

Sure. Yes. Absolutely. So we do feel like used vehicle affordability is having an impact on the average used car customer today to give a little bit of an example of that. In January, Carvana customers with greater than $100,000 annual income grew by 30 points faster than the company average, while customers with below a $50,000 annual income grew by 30 points slower than the company average. And we really do think that those types of data points, and the same thing was true, young versus older customers, for example, where younger customers are growing at slower than company rate. And then we really do think the key -- what that points to is this question of affordability in industry, we think it's impacting used vehicle dealers widely. And so I do think one of the things that means is, I think from our perspective, some normalization in used vehicle prices is -- would be a benefit to the industry as a whole in light of the affordability questions for the typical used car buyer.

Yes. And just kind of with the point of the concerns over affordability, rising rates in the near term, why would you say right now is kind of the time to unlock additional capacity?

Yes, absolutely. So I mean I think we feel really great about the trajectory that our business is on. I think we started the conversation with talking about cohort curves, but I think the cohort curves give us a lot of conviction about where our business is headed over time. And frankly, that's in -- even in a higher-price environment, I think customers are still buying cars. Affordability is having an impact, but there's still an awful lot of customers out there buying cars. And so when we look at our cohort curves, our oldest cohort of 2013 cohorts, the market of Atlanta, at 3.5% market penetration. If you apply that out to a 40 million used car market, that extrapolates to 1.4 million annual units. And Atlanta was still growing. It grew at just over 50% in the fourth quarter. And so we think that, that 1.4 million sort of full market applied rate, that's something we expect to grow -- continue to grow over time. And so we think there's a lot of demand for our product. We think we're going to sell an awful lot of used cars over time. And so this ADESA acquisition really accelerates our path to doing so by providing additional inspection and reconditioning center capacity, providing a wider geographic footprint, which aids the logistics network, and then there is other benefits as well.

And we have a bunch of e-mailed questions. I'm going to leave those to Jake, if you're -- who will probably ask a few of those. In addition, we had number of e-mailed questions ahead of time. So we're going to try to get through everything. I'm not sure that we will, though. So -- but next question e-mailed in earlier was, can you give us some color on the 4 strategic pillars of the acquisition? Is it fair to say that the assets were more valuable to you than the business when you're thinking about that -- the acquisition?

Sure. Yes. So I mean I think the 4 pillars, the first is just we think this accelerates our path to our long-term goal of being the largest and most profitable auto retailer. I think then there -- within that, there's sort of 3 primary strategic rationale for undertaking this acquisition. I think it starts with inspection and reconditioning capacity, where, when fully built out, we believe the ADESA sites support approximately 2 million units of annual retail reconditioning capacity. And that's something that we won't tap into on day 1. It will be a multiyear process to improve and expand the sites to access that full amount of capacity. But that's something that -- inspection and reconditioning is an important driver of our business, and we really see this as an acceleration of our ability to up scale inspection and reconditioning center capacity. So that's point 1. Point 2, there's very meaningful logistics benefits that come from having a widely distributed set of inspection and reconditioning centers. That's something that we expected in our core model build to take advantage of over time. Acquiring the ADESA site accelerates the process of having that widely distributed footprint. Having a widely distributed footprint, it makes inbound transport faster and easier, makes outbound transport to customers faster and easier. We think there's conversion benefits from over time, being able to offer same-day delivery to a wide set of customers and really expanding our penetration of next-day delivery, which -- based on our data, our conversion drivers. And so I think that's point 2, really accelerated logistics network benefits. And then last benefit is ADESA's built a great business here. It has a great team that's serving a lot of customers that we look forward to continuing to serve. Buyers and sellers of cars, added as physical auctions, have taken advantage of their footprint to efficiently move cars around. And I think that's something that we're excited to continue to support and provide the same level of customer service that we've always provided to our consumer customers. So that's sort of a third benefit.

You have quantified a 750 improvement in unit economics across inbound, outbound logistics. And a CAC transaction is within 200 miles of a consumer versus your average transaction distance today. Can you just elaborate on the drivers of this improvement?

Sure. Yes. Absolutely. So I would break it down. I think there's 4 sort of key elements of that mileage benefit. I think the first is inbound transport cost. When you have a widely dispersed set of scaled inspection and reconditioning centers, inbound transport becomes as easy as you buy a car from a customer online. One of your last-mile delivery add kits goes to the customer's door, picks up that car and takes it straight to one of our IRCs, whether it's a Carvana or an ADESA built-out IRC. That's very low cost. It's also very fast. So the first is low amount of transport cost. The second is fast inbound transport speeds. You can have that car sitting on the reconditioning lot, ready to be inspected and reconditioned within an hour of purchasing it from a customer. And so I think that adds some benefits as well. On the outbound transport side, putting more cars close to more customers by having a widely distributed geographic footprint lowers outbound transport costs because customers are more likely to find a car that's right next to them. And then if you have a less dispersed inspection and reconditioning network. And then it also improves delivery speeds, going all the way down over time to same-day and next-day delivery, and that has a positive conversion impact. So inbound transport cost, inbound transport time, outbound transport cost and delivery speed benefits on conversion and customer experience would be the big 4 things that I would point to.

Great, Mark. I'm going to pass it over to Jake Moser.

Thanks, Greg. I'm going to stay on some of these acquisition-related questions for a little bit, and then maybe we'll circle back to some of the current environment as well. But -- so you mentioned the acquisition could unlock 2 million units of additional capacity once all the locations are converted. So could you provide some -- just some more qualitative color on what exactly needs to happen to get those ADESA locations converted to a Carvana IRC?

Sure. Yes. Absolutely. So I think the first point I would make there is right out of the gate, the plan for ADESA is it's business as usual. We're going to continue running these physical actions. We're going to continue to service ADESA's existing buying and selling customers. And then what we want to do is add additional retail reconditioning capacity on top of that. Now ADESA is starting with some retail reconditioning capacity. They have always done some wholesale reconditioning, supporting sellers with light reconditioning to improve the value of their car prior to wholesaling. They've also started to add some retail reconditioning capabilities supporting various retailers. And so they have -- they're starting with some retail reconditioning capacity. But really where the big increases and getting to that 2 million units of annual reconditioning capacity will involve a multiyear time line of us selecting sites, making improvements to the site, getting the sites built out to have the capabilities of a fully scaled Carvana inspection and reconditioning center. So yes, that's sort of the thought process.

Got you. That makes sense. And I know you said that's kind of a multiyear process to get those all converted over, but is there any more color you can give on that time line? And maybe how we would compare versus if you have done this on a greenfield basis?

Sure. Yes. So we haven't provided any additional color other than making sure we're setting the expectation that it's going to be a multiyear process to fully build out these sites and take advantage of all the potential capacity that is within these sites. And so that's definitely going to be a multiyear process. However, I would say that we do view this acquisition as an acceleration. We're going to be able to move faster than had we gone city by city, selected site by site and built them out without the starting point of ADESA. So I think the number one way, our long-term vision has always been to have a national network of inspection and reconditioning centers in every large city. And so we would have marched toward that over time, absent this acquisition. And this really -- this reflects -- essentially, it will be easier, and we believe it will be an acceleration with having these centers.

That's it. That makes sense. Okay. So I guess how did you think about structuring the debt financing for this deal? Did you consider other alternatives? And then 2, why take on the additional sort of $1 billion of capital for the capital improvements? Why take that on today if the upgrades are a multiyear process?

Sure. Yes. So I think there's a few different frameworks that applied to the way we thought about the financing decision here. So the first, I think this is a very general corporate finance framework, is we think about how do we minimize our cost of capital. And the way that, that has typically played out in our business is we have various types of hard assets that we invest in as an auto retailer. Those include inventory and those include real estate, particularly inspection and reconditioning centers. And generally speaking, we believe that minimizing our cost of capital means financing your hard assets with that, that, in many cases, can be matched to the hard assets. So minimizing cost of capital and applying that sort of framework the way that we historically have is part of the way we thought about financing here. I would also say, we expect our business to generate meaningful EBITDA over time. I think we've given some color into that. We've laid out long-term targets, but we absolutely expect this business to generate meaningful EBITDA over time. And I think when you expect your business to generate meaningful EBITDA over time, that also supports the type of financing structure that we have outlined here. So those will be a couple of points that I'd make. I would also add, we have significant flexibility to execute this transaction with that financing. Our existing capital structure enables a very significant ability to fund this acquisition with debt. We have approximately a $1.5 billion credit facility basket in our existing indenture. We have a $1.5 billion general debt basket based on our balance sheet, total assets that provide ample flexibility. We have unlimited access to mortgage facilities and sale leasebacks. We can use those to an unlimited extent to finance this type of purchase or others. We have a general debt basket that relates to our market cap, which actually we do not need to use to execute this transaction. And so -- and also, that creates additional capacity to take on debt, incremental to everything that I just listed out. That's not a maintenance covenant in any way, but it does allow us to take on additional debt in addition to the several buckets that I listed prior. And so from a flexibility perspective, I think we feel really great about this transaction and the way we're approaching it.

Got you. So I mean, just talking about all the additional debt that you're going to be taking on for the deal, I mean, does that change the way you need to prioritize sort of growth versus margins in the near term? And then we just had a related investor question come in, like are you -- sort of more broadly, are you happy with your liquidity position sort of post deal?

So in terms of how we manage the business, I do think -- as I was saying earlier in terms of how we thought about this capital structure, we do believe we have a business that generates -- that will generate meaningful EBITDA over time. I mean we've gotten to the point where we've very steadily grown GPU and guided to another strong year of GPU in quarters Q2 through Q4. And so I think this is a business that we do believe will generate significant amounts of EBITDA over time. In terms of will we tweak the way we manage the business, I wouldn't say necessarily, but we do believe the business we're building is on a path to generate significant positive EBITDA over time. So I think I would say that. And then from a liquidity perspective, I also think we feel good there. I think we have very significant liquidity resources. I think one interesting thing about this transaction actually is that it will meaningfully reduce the Carvana core CapEx. Most of our CapEx in 2021 was related to building out the inspection and reconditioning centers that we built in 2021 and expect to launch in -- either have launched or expect to launch in 2022. And so we're going to build -- start building out and really focusing our efforts on building the ADESA footprint, which will meaningfully reduce the CapEx in the core business, because we'll be able to leverage the ADESA sites.

So I think just because you kind of opened the door to it there, and then I want to make sure we circle back on GPUs before we run out of time here, but how should we think about the pace of sort of Carvana built-out IRC openings in the near term, while the -- just given the ADESA acquisition and outside ramps?

Sure. Yes. So I do think the teams have made really great progress scaling our -- Carvana's stand-alone inspection and reconditioning center footprint. I think early in 2021, we set an outlook for opening 8 IRCs in the full year 2022. We opened one of those early, actually came online in Q4 2021. We've opened a second in February 2022. Of the remaining 6, 5 are well into the construction process, and we expect to open those in 2022. That will get our infrastructure capacity at full utilization up to about 1.2 million units once those 5 are launched. We have a sixth that is on track and on schedule to open in 2022. However, in light of the ADESA acquisition, we are evaluating the best time line in our view for that particular site. And then as I alluded to earlier, I think our focus from an inspection and reconditioning capacity will then really shift to making greater use of the ADESA sites, which will meaningfully lessen our investment in stand-alone IRCs.

Okay. That makes sense. Okay. So before we run out of time here, I want to circle back and touch on used vehicle pricing. I'm not asking you to predict what happens with used vehicle pricing, but -- from here. But if we were to see that normalize, how do you think about managing gross profit per unit in a declining price environment?

Sure. So I think on -- there's interesting trade-off that come when -- as it relates to gross profit per unit in a declining price environment. I think one is, other things being equal, during a period where there's retail price appreciation, which the industry generally sees seasonally. Sometimes, over the course of a year in a nonpandemic environment, there's periods of appreciation and periods of greater depreciation. But other things being equal, retail price depreciation has a negative impact, other things equal. However, there's a big offset because one of the things that happens in a declining price environment is wholesale market prices fall, which lowers your input cost, allows you to buy cars at less expensive values, which then can have a positive effect on GPU, other things being equal. So I think those are some of the key trade-offs. And we certainly -- all auto retailers have managed through environments where there's increasing prices, decreasing prices. It's all part of the industry.

Got you. And then kind of along those lines, we had an investor e-mail in a question asking about sort of, if you were saying you noticed increase discounting on the website, I was wondering if you had any sort of comment on why that might be?

So I think, in general, like the teams are running all kinds of algorithms, I'm not sure what that's pointing to exactly. But generally speaking, the -- our pricing policy in general has maintained, definitely offering a discount, no dock or dealer fees relative to big brick-and-mortar dealers. And yes, our policy generally hasn't changed, and I'm not sure about the micro optimizations that are happening there.

Absolutely. Understood. So I guess just one last one to finish up here. Like how do you think about sort of ADESA as an auction business or an earnings stream from here? I know you mentioned it's kind of business as usual in the near term. But do you see risk to maybe share loss? Are your competitor dealers maybe going to want to use Manheim instead of ADESA? And then what about nondealer customers? Because I think the OPENLANE business was put out from ADESA, right?

Yes. Yes. So I mean, I alluded to this a little bit earlier in the call, but very excited to continue to service ADESA U.S.' physical auction customers, whether it be buying and selling dealers or commercial sellers at the auction. I think we want to provide the same level of customer service that the ADESA team has been providing to those customers the whole time, the same level of customer service that we seek to provide to our customers at Carvana. So definitely excited to work with those customers and make sure we're providing great customer experiences. I think the -- yes. So -- and we're bringing over the team. We've had a chance to get to know some of the leadership at ADESA U.S., excited to bring over the team. I know there's a big team all throughout the country that's working to operate these businesses. We're excited to take them on. And yes, plan to be business as usual in this business, while also starting to layer in the retail reconditioning capacity and logistics capacity to derive some of the benefits that we discussed.

Well, thank you, guys, so much for the time. I think we're just about out of time here, so I'll turn it back to Greg. Thanks.

Mark and Mike, really great to see you, and thanks for kind of walking through the story and answering all our questions. Appreciate it very much.

Great. Thank you very much. Have a great one.

Great day.