Carvana Co. (CVNA) Earnings Call Transcript & Summary

Okay. So I'm Sharon Zackfia, and I'm very happy to have with us today from Carvana, Chairman, President, CEO and Founder, Ernie Garcia. Carvana is an online retailer of used cars with a customer-friendly buying process that allows customers to buy and sell cars through a simple intuitive digital interface. They had a transformational year last year, generating adjusted EBITDA of more than $300 million versus a loss of over $1 billion in 2022. We believe those profit gains are poised to extend further this year as used car unit sales begin to inflect into positivity for the first time since mid-2022. And adjusted EBITDA did exceed CapEx and interest expense for the first time ever in the first quarter. Management also recently -- I'm stealing all your thunder, Ernie. Management also recently quantified the potential for more than 6 points of future margin expansion on a tripling in units sold, which would translate into EBITDA margin slightly ahead of its long-held target of 8% to 13.5% and easily put Carvana in a class of its own in automotive retail. But before turning the podium over to Ernie, I need to tell you there's a complete list of research disclosures and potential conflicts of interest at williamblair.com.

Perfect. Well, thank you for coming. I see a couple of faces that I don't think I've seen since 2020. So I think that's at least directionally positive news, so we'll take it. We'll start with our riveting safe harbor. So I'll leave that up for just long enough to get credit for it, and then start with this. I think this graph to the right, I think, carries a ton of information. This is our EBITDA margin going back to inception. And I think we've definitely been through a ride over the last couple of years. We went public in 2017. We had an incredible run through '21. We had a tough '22, a tough 23, but we've made a great turnaround really quickly. I think in Q1, we had financial results that we're very proud of. We had a 7.7% EBITDA margin. That translates to $235 million of EBITDA dollars in the quarter. We did that while growing. And I think very importantly as well, if you view this graph on the right and you step back, it reduces to a pretty consistent gain over a very long period of time that we think is driven by big fundamentals. Customers love our offering. The team executes really well. The business model works. And there have undoubtedly been bumps along the way. The bumps in the stock price have been much crazier than the bumps in the underlying performance. But generally speaking, if you squint, that's a pretty straight line for real life, and it's something that I think we're very proud of. I think a reasonable mental model for how our business grows, of which there are many, is that there is a constant transition of customer preferences toward buying cars online. That leads to kind of a certain level of growth that is probably achievable with a consistent offering. On top of that, there's positive feedback in the business as we grow inventories, we grow marketing dollars, you get bigger, you get higher conversion rates, and you see that positive feedback. I think that mental model describes the vast majority of our history in terms of growth. You can see consistent growth for a long time through '21. That growth was paired with growing inventory and growing marketing dollars. And '22 and '23, inventory started to shrink dramatically as we adjusted to the new environment, made a bunch of changes in the business, shift our focus to profitability. And we also started pulling back quite a bit on marketing. So you kind of had this negative feedback and set of positive feedback that was overlying the natural kind of transition and customer preferences toward buying cars online. Q1 was the flattest period that we've had in a long time. I think you can look at us year-over-year, which massage out seasonal issues or you can look at it sequentially, which is kind of a more real-time estimate. We've put all the numbers of peers so you have them. But probably the simplest way is to look at it year-over-year. We grew by 16%. Year-over-year, inventory was down by 22%. So that still would have been kind of a negative feedback in terms of the underlying growth. And advertising was down 4% year-over-year. Sequentially, those numbers were 21% flat and negative 8%. But for the most part, you think about that is for the first time in a really long time, we were in a relatively flat environment. And so we -- or sorry, flat inventory and advertising kind of impact to growth, and that enabled us to turn back to positive growth. So we think that, that's exciting. It wasn't -- there weren't levers that were pulled. Margins got better. Inventory was down. Advertising was down. That's reflecting kind of natural underlying migration and customer preferences toward us. Hitting on the underlying economics of the business, we've made really, really rapid improvements. So in gross margin, we were up 620 basis points year-over-year to 19.3%. That's significant. That was driven by gains across the entire gross profit stack and retail gross profit in finance, in ancillary across the board. We drove down our expenses, both fixed expenses and variable expenses pretty significantly, down 17% year-over-year. That combined to lead our EBITDA margin up 860 basis points year-over-year. That's a tremendous move really, really fast. Again, that was driven by focus across the company. It was driven by a lot of great work by a lot of great people who broke down many different components of the business and focused in different areas. And we shifted our attention away from growth and towards just getting better in every part of the financial model, and that focus paid off really clearly. And I think it allowed the fundamentally good things in the model, which is a great business model. Customers love the offering and good people to express in our financial numbers instead of growth, which is where they had expressed for a long time prior to that. But again, something that we're very proud of. I think very importantly, there's questions. When our EBITDA margin moves up as quickly as it does, I think we get a lot of questions that are natural around how much of this environment and how much of this is sustainable. There's lots of ways to address those questions, but I think a pretty reasonable way to address them is to compare us to the ways that other automotive retailers are performing. If you look at the other public automotive retailers, they printed EBITDA margins between 3% and 7% last quarter. That puts our 7.7% in a really positive light. We're all facing a similar environment overall. I think interestingly, you can probably break the environment down into franchise and independence. Franchise dealers over a 20-year period have probably averaged 3% to 6% EBITDA margins very consistently, and they've kind of bounced around in that range based on their relative execution to one another. They roughly doubled over the last several years. I think there were a number of things. Some of the post-COVID distortions, I think, benefited franchise dealers quite a bit. And I think if you graph the demarks over time, that becomes exceedingly clear. Over the last 18 months, they've all been kind of tracking back toward their long-term averages. They're still a bit above that, but they're tracking backwards. Independents, I think, by many of the same forces were negatively impacted. And so generally speaking independents have underperformed their long-term averages, and they're generally tracking upwards a bit right now. That's certainly true of us. But we think overall, that bodes very well because for the first time, we were 7.7% EBITDA margin. That made us the most profitable automotive retailer as measured by EBITDA margin, which we think from a long-term view is a really good way to look at it because it's the underlying kind of enterprise value creation in the business. And so that's something we're very proud of as well. And I think comparing us to others puts that in a really positive way. We also have a goal of reducing leverage. I think the last couple of years demonstrated pretty clearly to us and everyone who is paying attention that leverage can be painful. And so we intend to decrease leverage. I think the way that we think about that is total debt that we've got outstanding, less cash divided by EBITDA, it gives us kind of a sense of our overall leverage. And through the lens of that equation, we've made a ton of gains in EBITDA. Last quarter was $235 million. We guided in Q2 that we expect our EBITDA dollars to go up. That compares to cash interest and CapEx of a little less than $50 million. So that starts to put some pretty meaningful cash on the balance sheet. We think we've got great plans to continue to move EBITDA higher, which we'll discuss later. And then we also -- in the quarter, we sold $350 million of equity through the ATM. We bought back $250 million of our notes. So I think from a net debt reduction perspective, you can take the sum of the equity and EBITDA, cash generation, and that's kind of reducing debt less cash or you can look at just debt dollars, and that's being reduced by the $250 million that we bought back. Overall, when you kind of extend that along with our intention to pay cash interest instead of PIK out through 2026, it has very meaningful impacts to our expected annual interest expense in '26, reducing that by $55 million. And our debt outstanding risen up by $620 million. And those numbers don't include the benefit of kind of the additional cash that isn't used to pay interest or to buy back these notes. I think we had a tremendously successful last 2 years really, but I think the last year was the best we've ever executed. I think going back in time, 1 year, we talked about the plans that we had for the year ahead. And I think it's always hard to know exactly what's in investors' minds. But I think for many reasons, we often don't discuss in two detail the way the specific projects that we're working on. And I think sometimes that can be received as sounded like there's less of a plan than there is. We absolutely have a plan the way that we roll that plan out. We've got what we call clusters, which are different groups of people inside the business and focus on different parts of the business. We've got an inventory cluster that does vehicle acquisition, reconditioning, vehicle pricing. We've got fulfillment cluster, which is market option to last-mile delivery and logistics. We've got customer care. We've got buying cars from customers. We've got various different clusters inside of the business. What we do every year, and we roll out our goals every June for the next June is what we aim for. We have all those groups bring their highest priority projects. The things that they think will move the needle the most, we work together to prioritize those. They then go away. They size the benefits they think they can achieve. They turn that into at least monthly targets, oftentimes, weekly targets. And then we have a weekly meeting cadence where we go through how we're tracking on all those different projects. I think from the perspective of a year ago, if you looked at those projects and you go to them individually, they were all high-value, very exciting projects that it made a lot of sense they can move the business. They all seem highly credible. The teams had a plan that seemed achievable. And when you added them up, they looked like something that would be extremely unlikely that we'd be able to achieve as a company in sum total. But then if you look 12 months forward, we achieved a lot. We improved our EBITDA margin by 8.6% up to an industry-leading number. And basically, our batting average across those goals was extremely high. We just went through the exact same process again. The teams have -- again, they have incredible targets that are clearly high potential that clearly can move the business that clearly can make a big difference in our financial performance. They look very credible one at a time, and they add up to gaudy numbers that anyone would be right to be skeptical about, but we're going to go out and try to do something pretty exciting again. So I think we're very excited about our next 12-month plan. We do think our business is very differentiated in terms of the types of unit economics it can generate. We have a completely different supply chain. We have a completely different method of fulfillment. We're vertically integrated in a completely different way, and the economics are just different as a result. And so we plan to go out and get that. This is aimed to show it can be -- a lot of times in conversations, it's hard to articulate all of the areas of potential improvement and all the ways in which we plan to go get gains. But if you go on our website and click around, if you buy a car from us, if you sell a car to us, my hope is that when you go to that experience, you're going to say, wow, this is different, and this is good. And that's the fundamental power that's available. I think you will also see a bunch of areas of opportunity. You'll see things you'll realize there's a lot of complicated things happening beneath the surface that can constantly be improved. I think you'll see things where you'll say, "why didn't they do it this way instead of that way?" A lot of times the answer to that is because it's hard and it takes time. You've got to invest in it. But when you have smart, motivated, ambitious people that are focused on each part of that business chain, who are putting together ambitious interesting projects, you can make a lot of progress really quickly. And there are many different components of the business where we have the ability to move things materially. So this at least gives you a sense of where those benefits can come from. Our goal has always been to build a business that allows us to economically provide customers with the best customer experience. We think the 3 primary ways that you measure that is the somewhat kind of soft, best experience, make things fast, make things easy, make things intuitive, make things low pressure, make it so you can do it on your own time, you can do it quickly or you can take your time, but you're in control, give customer selection. One of the benefits of an e-commerce experience is you have a global inventory. This means customers have much more selection. It means the economics are totally different. It means you're optimizing a different inventory problem than dealers who are optimizing for many local inventories. So there's a lot of opportunity there and then give customers the best value. That's achieved through the different underlying costs of the business, the different experience of the business and the vertical integration in the business. So I think there's a number of ways to deliver customers best value. We're in a massive market. Last year, there were 36 million used cars sold. That number has averaged about 40 million over a very long period of time. We're currently approximately 1% of that market. It's enormously fragmented. The top 100 players, 100, add them up, have 11% market share. That's about as fragmented as markets get, and that's also, we think, very exciting for obvious reasons. And further, I think there's already consolidation energy that is occurring. When we went public in 2017, that exact same stat was 7% market share. So at that time, the top 100 players had 7% market share. Consolidation is already happening. We think that we're a force that generates more consolidation. We think we're in a great position to benefit from that. Many ways to look at our TAM and our opportunity. I think one way is to look at e-commerce globally. Obviously, when you look at any different sector, there's kind of different trade-offs that customers get if they buy something in a traditional way versus e-commerce. But if you separate auto out and you say, what is just e-commerce in sum total, in sum total, as part of the retail market, e-commerce is about 19%, and it's growing about 16% per year on a compounded basis for 10 years. That's about the same on a 5-year basis, but it's much lumpier because it accelerated in COVID and then it's just started to grow again. But the growth rate has been pretty significant. We think that that's pretty interesting when we're 1% of the market. And in terms of a pure e-commerce opportunity, we're pretty much the only player out there. So we think that that's very exciting. I think when you compare us to other e-commerce markets, some of which are much higher than 19%, some of which are lower. I think it's interesting to think about what is the natural e-commerce penetration in auto versus these other markets. And I think the negative to start with that is there's less habit formation in auto. People buy cars once every 5 years versus kind of having settings in a button you click to get toothpaste delivered every month, however often you brush your teeth, which I'm looking at here in the audience, it looks like most of you have a good job with that. But I think in automotive, there's less habit generation, but there's more of an impact you have on the customer, right? It's like I think you can think of the likelihood someone comes back, it's what is the strength of the impact you have on them divided by time. People forget in time, memory decays and time, but the impact you have is what kind of starts that. When you're saving someone $1,000 and you're giving them a simple experience and they feel zero pressure, that's a pretty big impact. So we think in terms of impact, it's pretty meaningful in terms of savings that are available, it's pretty meaningful. So we think that's at least an interesting way to think about how we can grow with these general trends that have been out there for a long time. I think one of the benefits of being wrong about the growth that we would see in 2022 is that we've built an enormous infrastructure that's ready to grow into. And so if you look across the various operational components of the business, we've got a couple of things laid out here. What is our retail unit throughput? That means reconditioning capability? What are our parking spaces? What do we have in terms of market hub and vending machine capacity in terms of single car haulers, multi-car haulers? We already own these trucks. We bought them in anticipation of volume that we didn't see in 2022. So they're sitting there ready to be used. They're showing up in our D&A today. And then desk occupancy, we also have meaningfully more office space than we need. That's not great from a current efficiency perspective. It is great from "making growth easier looking forward" perspective. So we're very well positioned to grow, and we have an infrastructure that is significantly different than anything else out there. We use kind of these underutilization rates to demonstrate that we've got about 1.3 million units of capacity, which is around 3x the size that we are today that's basically already built. In addition, the hardest thing to build from a capacity perspective is reconditioning space and parking spaces to get the real estate part of that equation done. Through our best acquisition, we have 56 additional locations. We think overall, when we add reconditioning capabilities to those sites, that gets us to 3 million units of capacity, which is around 8x our current scale. So we're very well positioned for a very significant scale in the future. This is another view of similar data points, but it also helps to demonstrate how growth will be different in the future than it was in the past. So if we go back to 2019, you can see our footprint of reconditioning centers. It was generally in areas that were easy to get approvals from local jurisdictions. It was concentrated in the south and in the Midwest. If you overlay our inspection centers today in the ADESA sites, you can see that we have a very complete footprint that has all kinds of meaning. But as it relates to just the difficulty of growth, it means that you're not building the machine as you go. What we have to do from here is higher and train. In the past, we had defined locations. We had to get locations approved for zoning. We had to build out locations. We had to add to our logistics network. We had to buy trucks. We had to buy multi-car hauler. There were a lot more things we had to do. Today, we have to hire and we have to train. Because those facilities are open, they're producing cars. So it's a much easier form of growth than we've had in the past. I think in summary, it's -- our view is that we're unbelievably well positioned, and we now need to execute really well to unlock this huge opportunity that sits in front of us. We would like to believe we have the best customer experience. I think there's some empirical data that validates that. In the first quarter, we had industry-leading retail growth for a long time. We grew at tremendous rates. I think we've always had this goal of being the largest, most profitable automotive retailer. I think if we go back in time to 2021, I think everyone believed we'd be largest. I think people question whether or not we can be most profitable. But we've returned back to growth. In the quarter, we also had industry-leading EBITDA margin. We're excited about that because we think that not only is that a great fact, but there's a lot of improvement left to be had, and we plan to go get it. So we think the most profitable part is on a very good path. We are committed to reducing leverage. We felt the pain of that along with many of you. And so we will reduce that leverage over time. We saw some moves that we made today. We're in an unbelievably large market with fragmented competition that operates in ways that are largely similar to one another and pretty different from the way that we operate. That's exciting. We've got an enormous footprint up to 3 million units of capacity. And so we think that now the opportunity we stand in front of is extremely exciting. It's clearer than it's ever been. We've taken everyone for quite a ride over the last couple of years, but we think the payoff at the end of the rainbow as big as long as we keep executing, and that's the plan. So that is the completion of prepared remarks. I'm supposed to give a moment for them to turn off the feet and then we can jump into the break.