Carvana Co. (CVNA) Earnings Call Transcript & Summary

Great. Good morning, everyone. Thanks for coming. My name is Rajat Gupta. I'm a member of the Automotive Equity Research team at JPMorgan. Very pleased to have with us Mark Jenkins, Chief Financial Officer at Carvana as well as Meg Kehan, in the audience here, Senior Director of Capital Markets and Investor Relations. So I believe Mark has a few prepared remarks and a slide deck to go through, after which we'll go into Q&A and also give the audience an opportunity to ask some questions. With that, thank you, Mark.

Thank you very much, Rajat. Happy to be here again. I think we've been at this conference several years running now. Thank you for having us. The presentation I want to walk through today is, it will start with a little bit of background, which I think most people in the room are probably familiar with. But what the real goal of the presentation will be is to dive down into some of the very significant fundamental efficiencies that we've gained in the business over the last year or so. We'll really focus in on retail and wholesale GPU, where we've made, I think, really significant fundable gains that showed up in our Q2 results, but we haven't spent much time so far talking about quantitatively and talking about in detail what's really driving all of that progress. And so that will be the [primal] of today's presentation. So with that, I'll start to get into it. So I think here's the safe harbor for forward-looking statements, which we always include and then the 2 slides on background. So I think most people probably have a pretty good sense of Carvana's recent history. Over our first 8 years as a company from 2013 to 2021, we were one of the fastest-growing companies of all time. I think we were 1 of the 4 fastest companies ever to join the Fortune 500 with only Amazon and Google growing faster. And so I think we've really focused on growth in the business for our first 8 years and we're very successful, growing market share, growing revenue, growing units very, very quickly. 2022 was a bit of a transition year. So we overbuilt the business for 2022. I think the demand environment rapidly change in used vehicle industry and for our business with very high used vehicle prices and rapidly rising interest rates. And in overbuilding the business in 2022, we took a very significant step back in our financial results. Again, I think everyone is aware, but GPU fell for the first time, adjusted EBITDA losses increased significantly and EBITDA margin fell for the first time. And we really switched our focus at that time toward -- a shift toward focusing on operational efficiencies and profitability. And I think 2023, moving to this year, is showing the fruits of some of that shift in priorities and our really intent focus on making sure that we're building a very efficient, profitable business that can scale profitably and grow profitably when we ultimately decide to return to growth. And so 2023 has been very successful on that front. We set first quarter records on total GPU and adjusted EBITDA margin in Q1. We set all-time company records for total GPU and adjusted EBITDA in Q2. We expect to set records on those 2 metrics -- the third quarter records for those 2 metrics in Q3 as well, which I'll talk a little bit more as we go through the presentation. So 2023 is really, I think, has been a very successful year so far. We completed our first goal and the 3-step plan we've laid out. We achieved positive adjusted EBITDA in Q2. We've moved on to step 2 of our plan, which is to drive significant adjusted EBITDA per car sold on a sustained basis. We sometimes have referred to that step 2 as drive significant positive unit economics. But really, what we mean is drive significant adjusted EBITDA per car sold on a sustained basis. And so that's where we are right now. Step 3 of our plan, of course, is to return to growth when we feel like we are ready. Okay. So just as another quick background slide. I think I hit most of the key points on this, but 2023 really has been a year of returning to the trend that we have been on. The last decade for our first 8 years in existence, we improved total GPU for 8 consecutive years before 2022. We improved EBITDA margin for 8 straight years before 2022. 2023 is back on trend. 2023 will make it 9 out of 10 years of improvement on those key profitability metrics. Okay. So that's the background. I think everyone has seen our recent Q2 results as well as our Q3 outlook. I think one of the things that we wanted to spend a little bit more time talking about here in this presentation is some of the fundamental drivers of the very significant we've seen -- success we've seen in driving profitability in the business. in Q2 relative to where we were, certainly, last year, but even in 2021, which was our previous high watermark for profitability. And so we're going to break this segment into 2 different sections. First, I'm going to talk about retail GPU then I'll talk about wholesale GPU. These are some of the areas where we've seen the biggest fundamental gains. And in retail GPU, I'll break things down into 4 key areas where we've really made significant fundamental gains, improving cycle times or inventory turn times, lowering costs in the inspection centers and logistics network, buying more cars from customers from a vehicle sourcing perspective and generating additional revenue streams from our fulfillment network. And all of those in total, sum up to a range of $600 to $1,100 of total retail GPU improvement that we believe is fundamental and sustainable relative to a benchmark of full year 2021. So that's sort of the outline for what we'll talk about next, and then I'll dive into some of the details. So the first key driver of our success, our recent success on retail GPU, is what I'll call normalizing inventory size or really it's more about normalizing inventory turn times. So the chart here on the left shows our average days to sale metric by quarter from Q1 2021 up to our expectation for Q3 '23. Average days of sale is particularly -- it's the number of days between when we acquire a car either from a customer or in the wholesale market and when we sell a car to a customer on a completed retail transaction. And so you can see just as a benchmark, 2021, we were running on average in the low 60s average across the 4 quarters. We really increased this metric, which is unfavorable for retail GPU because if you hold the car longer, it has more time to experience depreciation before you sell it, then thereby selling at a lower retail GPU. But it stayed really elevated through 2022 when we overbuilt the business for the ultimate sales environment. You can see it sort of in the mid- to high 90s there through most of 2022. It was really high in Q1 where we really sort of put the pedal down on moving aged inventory. You saw the cars we sold into 1 were on average 130 days old. That's really old, that's not normal. And we've really now started to see the normalization of this average day sale metric. We improved by 40 days going from Q1 to Q2. That is the single biggest driver of the sequential step-up that we saw in retail GPU going from Q1 to Q2, was that big reduction in days. We expect an approximately 20-day further reduction in Q3 relative to Q2. And then we also expect it to drift down into that low to mid-60s range, which is our near-term target, as we look toward quarters beyond Q3. So I think one of the things I think -- this is one of the useful metrics to help understand some of the fundamental improvements we're making in retail GPU. I would say we've got a 20-day improvement going from Q2 to Q3. There were some transitory tailwinds that helped retail GPU in Q2, but a 20-day improvement in average days of sale going to Q3 is obviously a fundamental tailwind that will help Q3 relative to Q2. So even as some transitory tailwinds in Q2 burn off, we've got fundamental gains going to Q3 that will help retail GPU. All right. So the next category, a fundamental gain in retail GPU is ust fundamental cost improvements. And this, I would say, this is my favorite slide in the whole presentation because what this slide captures is a lot of fundamental improvement, not only relative to 2022 when we were very inefficient relative to historical norms, but it also captures very significant fundamental improvement relative to FY '21, which was our previous high watermark for retail GPU and total GPU. And so what this chart on the left shows is it's quarterly from Q1 2021 to our expectation for Q3 2023. It shows the difference between 2021 costs on conditioning and inbound transport which are the sort of fundamental items other than vehicle acquisition costs that drive retail cost of sales. And it shows the difference between[indiscernible] '21 value and what we are on a quarterly basis. And so there's a few things that I think are really sort of helpful to point out on this chart. One is that our operational focus is paying off. So we made very, very substantial gains since 2022, in sort of early to mid-2022, our teams really shifted their focus to operational efficiency. And since that time, you can see we've made very large changes to cost per unit in the reconditioning centers and inbound transport network. I'll talk a little bit about what's driving that. The single biggest source of the gains over that time period have been in-sourcing. So basically taking all production in-house, some of our party production was actually at ADESA in 2022. We obviously have internalized that. So we have the opportunity to sort of integrate some of our processes as well as internalize any margin that ADESA was earning prior to our acquisition. And then we've really focused on also in-sourcing services at more and more of IRCs as the single biggest driver. But we've also made gains elsewhere. I think just getting our staffing right, standardizing processes across the nationwide network of inspection and reconditioning centers, making real improvements in developing our proprietary systems that run the IRCs and determine how the cars go through the process, getting efficiencies and acquiring parts, for example, it by software. So we've made big gains there. And we've also made big gains on inbound transport basically driven by having more locations where we recondition, which allows us to reduce inbound transit miles and also just getting better utilization on the inbound transit network. So all those fundamental gains, I think there's a few things that excite us about them. One, over this period, our vehicle quality metrics have been stable, which means these fundamental improvements are not coming at the cost of reconditioning quality. They're really coming from fundamental gains in the way we're operating the business that we think are sustainable. On that point, we also think these gains are not the type of gains that all of a sudden reverse when you start to return to growth. So some of the key sources of gains actually improve when you start to grow, including logistics network utilization and inbound transport miles, right, as you start to grow, you're increase reconditioning capacity where you're acquiring cars, thereby lowering that inbound transport distance for certain cars that you acquire. The others we think are real fundamental sustainable gains that don't require a reversal when we ultimately return to growth. So those are some of the qualitative points. Again, I think we feel really good about this progress. I think it was an amazing success for the teams involved in it, and I think bodes really well for our outlook on retail GPU and our outlook when it's time to start scaling volume again. Now diving into a couple more of the numbers. So you'll notice in the slide, one of the drivers of the sequential improvement in retail GPU going from Q1 to Q2 was some of the cost efficiencies flowing through. So in this chart, you can see the step down from $180 relative to FY '21 to minus $180 relative to FY '21, it's about a $300, a little over $360 sequential improvement in cost per unit sold. We do expect further improvements in cost per unit sold on cars sold in Q3. You can see expect to go from minus $180 relative to FY '21 down to a midpoint of minus $350 relative to FY '21. So we do expect further sequential gains on this metric in Q3 relative to Q2. As I said with days of sale, this is a real fundamental gain that will help retail GPU in Q3. There were some transitory benefits that helped it in Q2, but we can say this is real fundamental gains that are going to help sustain a strong retail GPU as we look forward in the coming quarters. And then last, on the numbers, I think a really helpful thing to keep in mind, in Q3, we do expect to be $300 to $400 per car sold better on reconditioning and inbound transport costs than we were in FY '21. That's real fundamental sustainable gain. Okay. So moving on to the third of our 4 drivers of retail GPU. So over the years, we've had great success with vehicle sourcing. We source a lot of our vehicles directly from customers. We have an amazing customer offering from a customer experience perspective, where people can get a real value in minutes on their phone or desktop. And we'll come to the car, pick up their car and hand them a check. That's an incredible customer experience. It has had a lot of uptake with customers, and it's led to see gains in customer sourcing over the years. Our customer sourcing ratio is basically the percent of retail units sold that were sourced from customers versus be in the wholesale market. is about 83% so far this year. That's up 10 points from 2021. We think that this kind of mid-80s -- low to mid-80s range is around the upper end of our target range. We don't see ourselves pushing to the point where we're all cars sourced from customers. We do think it's useful to source cars elsewhere in the wholesale market. And so we don't expect this number to drift up much from here. I think our future gains in the area will be focused on customer experience and just improving unit economics by making sure we're buying the right cars. But in total, relative to FY '21, which is the benchmark for this discussion, we view this as approximately $100 to $200 fundamental benefit. Okay. So the last source of fundamental gains in retail GPU that we see today relative to where we were in FY '21 is on driving additional revenue streams through our logistics network. So one of the big advantages, we believe, of our model is the ability to make a very large selection of cars available to customers conveniently and cost effectively. And the chart on the left actually highlights some metrics around that way that we think about our selection advantage. And again, this is enabled by the fact that we've built this consumer-facing first-party logistics network and invested very significantly in the network itself as well as the technology that backs the network. So on the left-hand slide, we picked our oldest market of Atlanta and just looked at the local dealer inventory in that market as proxy by the listings that show up on carguru's platform. It's about 50,000 cars that show up in the Atlanta market. Carvana today makes available just over 25,000 cars in that market. So the cars that can be delivered to customers' door in Atlanta are 50% as many cars as the entire Atlanta local dealer market as proxy [carguru's and] things. So that's a big, big selection. Now if you think about -- if we're 50%, if you add us plus the market, we're about 1/3 of the available cars at least across those 2 channels. And so we, in our view, that points to over time continue to take a very large market share as consumer behavior normalizes around online car buying. But at any rate, I think the main point today is, we have a very big selection that we can offer to customers in Atlanta. We also have a very big free shipping selection. So we have started to charge shipping fees on longer distance shipments that's generated about $300 of incremental revenue relative to FY '21. We're able to do that because we've built this first-party network. But importantly, we still have a very large selection of free shipping cars available to customers in our markets using Atlanta as an example,we have about 3x as many cars as the next largest alternative dealer. And so we do have the largest selection of free shipping cars available in a market like Atlanta, which we think is really great from a longer-term perspective. All right. So main -- I think we've hit the main takeaways here. So the next slide is just going to sum up -- it's just going to sum up what we talked about on the previous slides, and this is building up to that $600 to $1,100 of fundamental gains in retail GPU that I talked about in the intro to this section. You see here, we've got $300 to $500 of lower costs. The $500 is a little bit higher than the $400 that we had at the top end of our Q3 range because we do see further gains that we have the ability to make by the end of the year. Expanded customer sourcing and additional revenue streams come from the previous slide just with a range around them. And so FY '21 non-GAAP retail GPU is about $1,700. And off of that baseline, we feel like we've made in the business really significant fundamental gains that supports much stronger retail GPU in a way that is sustainable and can persist. I think we've done it for one quarter. I think we recognize that it's going to take multiple quarters of demonstrating this new retail GPU model for it to be fully appreciated but we do feel like we made really significant fundamental gains that allow sort of a new level, a new persistent level of retail GPU. Okay. So that wraps up my comments on retail GPU. We've talked about these -- the drivers that I just walked through qualitatively in our materials, including our shareholder letters, but we wanted to provide some additional quantitative data to help make things a little bit more tangible in terms of the gains that we've made. Okay. So now I want to move on to wholesale GPU, which is another area where we've made very significant fundamental gains in the business since 2021. I think those fundamental gains are led by the acquisition of ADESA, which does 2 major things for us. First, it generates an additional stream of gross profit and EBITDA just from the ADESA business of third parties exchanging cars through the ADESA platform. In addition, the acquisition of the ADESA business and the 56 physical auction locations that came with ADESA, enable us to have an infrastructural base for expanding our business of buying cars from customers and selling them in the wholesale market to dealers that want to buy recondition and retail those cars. And so that's what I'll talk about in the next few slides. So just kind of making a couple of those points quantitative. So on the ADESA business itself, I think 2023 has been a really good year from an improved growth and improved profitability perspective. 2022 was a down year for the industry as a whole from a volume perspective and is also a down year for ADESA. I'll give a little bit more data on that in 2 slides. But we're growing volume at ADESA this year. I think total growth so far this year is about 10% year-over-year. That reflects a market share gain based on industry data sources. So ADESA is outgrowing the broader auction industry based on the industry data sources that we use. And then I think ADESA also is now generating positive adjusted EBITDA with an opportunity to generate meaningfully more positive adjusted EBITDA over time. I'll talk about that in a couple of slides. In terms of the impact on Carvana's total business 2021, I think that could be captured by the chart on the right. So wholesale GPU, combining the third-party marketplace platform as well as our platform of buying cars from customers and wholesaling them, average about $450 per retail unit sold in 2021. That stepped up to -- it's over $1,200 in the first 2 quarters this year. We expect that to step down in Q3, primarily because of the very significant wholesale market depreciation we've been seeing but still at Q3 and certainly year-to-date levels, a big step up in this area relative to FY '21 that we think is sustainable and even more than sustainable, we think is growable over time. And that's what I'll talk about on the next couple of slides. So the wholesale platform is just -- it's an area of the business where you see a significant growth opportunity looking forward. And I'll again break it down in those 2 categories. In terms of the next 2 slides, these categories will be, one, cars we acquire from customers and sell to dealers in the wholesale market. And there, we've made a lot of progress over the years. Over the last 3 years, we've grown that volume of buying cars from customers and wholesaling them in the wholesale market by 60% CAGR up to 170,000 annualized units. However, that leaves a huge gap between us and the largest player in this market, which does about -- in the trailing 12 months at about 560,000 units growing at 11% CAGR. This is an area where we see meaningful opportunity to expand our business. Now that we've taken on ADESA, we have the locations to be able to intake the cars, inspect them, store them, get them out to dealers that may want to buy inventory that Carvana can source from its customers, given its brand, its last-mile delivery network and its infrastructure for being able to stage and wholesale these cars. So we see this as a big opportunity. It's an opportunity that we plan to go after. We put some math up here at a target $800 to $1,000 per wholesale unit sold, matching the largest player, which is a stretch goal, but one that we plan to go after generate $300 million plus of annualized EBITDA. All right. The other part of the wholesale platform is ADESA. And I think there's a few things that I think we're excited about here. One, this year, ADESA has started to generate positive EBITDA. It's $23 million of positive EBITDA year-to-date. That's not including any of the synergies with Carvana. For example, the cost synergy that I described earlier with internalizing reconditioning margin at ADESA per cars that they recondition on our behalf. That's a cost synergy that impacts retail GPU, but wouldn't show up in ADESA EBITDA. The wholesale transport, inbound transport benefits that we talked about in one of our previous shareholder letters, another cost synergy that's significant in our integration with ADESA, but wouldn't show up here in ADESA EBITDA either. So this is a number that is -- just the ADESA third-party market believes business without any revenue, gross profit or synergies with Carvana. And so I think that's a positive step from 2022 in the first place. But moreover, I think one of the things that we're optimistic about is 2022 from a volume perspective in the industry was a really depressed year. The chart on the left here shows from an industry data source, the national auction [run] annually. And you can see the auction industry has gone through ebbs and flows, stepped down meaningfully in the financial crisis and then rebounded, step down significantly post-pandemic, but has started to rebound in 2023. Just the industry sort of growing cyclically is a meaningful contributor to ADESA EBITDA over time. And of course, ADESA just growing with the industry doesn't count our opportunities for operational efficiencies at ADESA or for taking market share. And so the -- I think the opportunity for us at ADESA is even bigger than just an industry rebound. We think we have the opportunity to take share. And indeed, we are [indiscernible] so far in 2023. So I think those are the 2, I think, main points that I wanted to share on wholesale GPU. The main takeaway there is our wholesale GPU, driven largely by the acquisition of ADESA and what it does both in its own business and for our wholesale vehicle business has caused a meaningful step-up in GPU relative to 2021. But moreover, we see this as a growth opportunity with an opportunity for additional gross profit and EBITDA contributions from these 2 businesses. So that wraps up my comments on wholesale GPU. I have one more slide, which is an update on Q3. So in our recent shareholder letter, we provided an outlook of over 5,000 GPU and positive adjusted EBITDA. We said there was some upside to that outlook. But early in the quarter, it was -- we went with 5,000 and positive adjusted EBITDA. We are updating that outlook today. So we're updating the outlook on GPU and adjusted EBITDA on GPU. We're updating to over 5,500 on adjusted EBITDA. We're updating to over $75 million of adjusted EBITDA in Q3. I think for putting that into a little bit of perspective. In Q2, we had some onetime items that impacted our adjusted EBITDA. We had some benefits from previous valuation adjustments on our inventory that positively impacted it. And we also sold more loans than we originated, which positively impacted in Q2. In Q3, our outlook assumes no significant impact from inventory valuation adjustments. We think we're back into a normalized world there unless something really changes quickly and dramatically in the industry. But the outlook does include some loan sales in excess of the loans that we originate and to be specific about that, it assumes $300 million to $500 million of incremental loan sales above what we originate in Q3, just to put a little bit more context about the outlook. And so with that, that wraps up my presentation, and we can hand it over for Q&A.

Great. Thanks, Mark, for the detailed presentation and all the color, very helpful. I just wanted to follow up on the third quarter guidance. The $5,500-plus GPU. If you look at the second quarter, it was $7,900 of onetime benefits. It looks like you're still going to have a little more backlog clearance on the finance GPU. My math would suggest like there's like $300, $400 of benefit from that. You mentioned the $250 of retail GPU going away, but there's the day sale benefit, that would equate to somewhat like $300, if it's 20 days better, there's a recon cost benefit around $150. So the math would imply something close to like $6,500 despite all the one-timers. So where are we missing between the $5,500 and the $6,000 are just leaving some more room for seasonality or anything else that we might be missing?

Sure. Yes. So I think the one thing I alluded to a couple of times, I think, is worth calling out. So we don't go through exactly that process. So if we just start with Q2 GPU and add everything I walked through in this deck is we do think Q2 had some tailwinds. One, I think we think Q2 is typically a strong quarter for retail GPU. And so just even a sort of a normal seasonal tailwind would create some tailwind in Q2 that might not be as strong in Q3. And then we also think Q2 benefited a little bit from some transitory market dynamics, in particular, just wide spreads and low -- widespread [screen] wholesale and retail prices and low retail to lower-than-normalized retail depreciation in the quarter. And so I think that's an important thing to keep in mind. So you just don't take our Q2 GPU and add everything I just walked through. I think more of what we're trying to get across is yes, Q2 benefited from some seasonal market dynamic tailwinds. But there's still a lot more in the tank, both on fundamental improvements in days of sale because Q2 cars were 91 average as a sale, which is well above normalized and on costs where we have very clear visibility into another significant step down in cost in Q3 relative to Q2. So that's the way I would talk about all those things balancing out.

Got it. Got it. That's helpful. Maybe I'll ask one more question and give the audience opportunity to ask another one. You've completed step 1 of the plan. You mentioned you're ready to move to step 2. But if we look at the second quarter results, even taking out some of the [recurring] nonrecurring benefits and seasonality, it's still like a pretty healthy EBITDA per unit level, like, call it, like $1,000 like, give or take. Is that not significant enough for you to move to step 3? Or would you like to take this higher before you start to return to growth? Because in step 2, you mentioned significant unit economics before we were going to step 3's growth. So aren't we already there with like $1,000 EBITDA per unit? So what's it kind of like there?

So I want to stay away from setting a specific dollar per unit target for when we return to growth. We do want to maintain some flexibility there as opposed to having a very specific number. But I think the way that we're thinking about this is in step 2, we still see significant opportunities to improve adjusted EBITDA per retail unit sold on -- in a stable volume environment before returning to growth. And the reasons we see that are, we've made an awful lot of gains in the last year. I think you've seen those in our results. I think from Q1 2022 to last quarter, we improved by -- on the order of $500 million of quarterly EBITDA closer to $400 if you get rid of some of the onetime benefits that we had in Q2, but we're really making a lot of gains, and our teams are really focused on driving profitability, and it's going well. We want to continue it. So just from a prioritization perspective and a company-focused perspective, we see more opportunity ahead even on stable volumes. And so we want to allow the teams to continue to tackle those opportunities. So I think that's the leading motivator for us staying in Q2. And then I would also add, when we return to Q3, our goal is to have that be profitable growth. So we get questions sometimes, hey, when you start to grow again. Are you going to see significant step back on all of these efficiency improvements that you made? And I think the simple answer to that is, that is absolutely not the way we think about it. Our goal is to have growth be profitable growth. And one of the sources for that profitable growth and one of the reasons we think we can achieve profitable growth is, we are operating today with a very significant base of fixed category costs. So I think about things like corporate expenses, technology expenses and facilities expenses. We think we have -- that's a significant part of our SG&A today. And we think we have the ability to meaningfully grow units into that corporate technology and facilities cost base, which makes growth a meaningful lever of SG&A when we finally get to step 3 and return to growth. And so that's a little bit of extra color. I talked about why we value stage 2 and why we want to stay in stage 2, but then we're also optimistic about Phase III and what that can mean for SG&A leverage because we do have an elevated and significant core tech facilities component of SG&A expenses today.

Got it. That's helpful. Maybe one quick question from the audience as we're out of time here. Anyone? No, I guess we'll end it there. So thanks, Mark, for doing this, and thanks, everyone, for joining.

Thank you, everyone.