• Blinders Off Research


Cash Burning Machine Or The Future Of Automotive Retail

  • Carvana’s GPU growth is not sinister, it’s a byproduct of increased efficiency.

  • Carvana’s considerable advantage over traditional retail dealers.

  • A secular shift in consumer purchasing behavior and the way businesses sell their products.

Business Strategy

Carvana is an online-only used-vehicle retailer that’s been getting a lot of attention from the investment community (not all good). In its early days, Carvana’s low gross per unit and poor efficiency in terms of days to sale was a concern for investors. However as time went on, those metrics improved dramatically (leading some to question their validity/sustainability) and I think it’s important to understand the reason why.

Imagine building a large used-car dealership in an area with a small population because you thought the population would increase in the future. At first, the small population would translate into limited demand for the dealer’s inventory and it would take a significant amount of time to sell a vehicle. The long period of time to sell a vehicle would also lead to smaller margins (dealers generally drop prices at regular intervals as used-vehicles age). Now imagine that a large company opens a factory nearby creating new jobs and the population starts to grow. As the population grows, the demand for the dealer’s inventory would increase, the average days to sell a vehicle would decrease and margins would rise as a result of fewer price reductions. That’s exactly what’s happening with Carvana with one very important difference. Unlike traditional dealerships which are mostly limited to the demand in their local market, Carvana stores most of its vehicles at IRCs (inspection and reconditioning centers) and increases demand by entering into new markets which they describe as:

We define a market as a metropolitan area in which we have commenced local advertising and offer free home delivery to customers with a Carvana employee and branded delivery truck. We view the number of markets we serve as a key driver of our growth. As we increase our number of markets, the population of consumers who have access to our fully-integrated customer experience increases, which in turn helps to increase the number of vehicles we sell.

As Carvana enters more markets, the demand for the inventory held at their centralized locations increases. As the demand increases, the days to turn their inventory falls and margins increase as a result of fewer price reductions. The chart below illustrates the impact of increasing markets on days to sale and the effect of lower days to sale on gross per unit:

It’s also important to note that the days to sale figures are slightly inflated because the price of a vehicle is agreed upon before delivery. Carvana does not stop the count on days to sale until the vehicle is delivered to the customer. There’s still room for improvement but as more markets open, the days to sale will continue to decrease and gross per unit will continue to grow/stabilize.

Advantage Over Traditional Retailers

Perhaps the biggest advantage that Carvana has over its competitors is their ability to scale at a blistering pace. According to NADA, the average investment for a franchised dealership, which includes the building and inventory of used vehicles, was $11.3 million per dealership in 2017. That’s considerably more than Carvana’s cost to enter a new market as stated in their financial reports:

Each new market has typically required approximately $0.5 million in capital expenditures, primarily related to the acquisition of one to two branded delivery trucks, a multi-car hauler to connect the market to our logistics network and furniture, fixtures and equipment in a local office space. As a market scales, we may elect to build a vending machine in the market to further increase customer awareness and improve fulfillment. Each new vending machine has required on average approximately $5.5 million of capital expenditures, depending on the number of stories in the vending machine tower and local market


While the clear advantage in cost to enter a new market is important, it matters little unless consumer demand supports the expansion. In my opinion, there’s no better gauge of consumer demand than sales volume. So how does Carvana’s online-only approach to used-car sales stack up against its more traditional competitors? Since Carvana is still in an aggressive expansion phase, I think the best way to answer that question is by comparing the number of sales per store (in Carvana case, markets) during a given time period:

As we can see in the chart above, Carvana is outperforming very worthy competitors in a sales per store/market basis and is only bested by Carmax in the publicly traded dealer category. This is undeniable proof that consumers are showing strong support for Carvana’s online-only approach to selling used vehicles.

Vehicle Acquisition

My biggest concern when evaluating Carvana is their ability to acquire enough inventory to fuel the growth rate which currently supports their stock price. I say this because standalone used-vehicle stores have a notable disadvantage over traditional retail dealers: less trade-ins (new-vehicle sales provide a greater percentage of trade-ins that can be kept and sold compared to used-vehicle sales) and no lease returns (matured leases are returned to new-vehicle dealers which have the opportunity to purchase the vehicles before they are sent to auction). Without the benefit of additional trade-ins and lease returns enjoyed by franchised new-vehicle dealers, standalone used-vehicle dealers are forced to acquire the majority of their inventory at wholesale auctions. The dependence on wholesale auctions puts Carvana’s retail volume growth at risk if the supply of wholesale vehicles falls and the demand from competitors with a similar business strategy grows in the future. To mitigate that risk, Carvana is focusing their sourcing and acquisition efforts on direct purchases from consumers:

The sequential improvement in vehicles sourced from customers as shown in the chart below is a positive sign that Carvana can grow their inventory by means other than wholesale auctions:

I believe the percentage of vehicles sourced from customers will continue to grow and my indicators are currently showing an increase in inventory of ~19% compared to Q4 of 2018; both are a good sign for continued sales volume growth.

Short-Term and Long-Term Outlook

In the short-term, it’s possible that gross per unit will come in at the low end of guidance for Q4. Carvana still has room for improvement when it comes to efficiency as measured by days to sale. The biggest threat to inefficient retailers (margin contraction explained in this video) is a large drop in used-vehicle prices like the one captured by the used car and truck CPI report for September of 2018. However, as I mentioned earlier, by continuing to expand into new markets, Carvana’s days to sale will continue drop which will increase their ability to manage price shocks (fewer days to sale leads to faster acquisition cost averaging). If gross per unit disappoints when Q4 earnings are reported on February 27th and the share price drops, I would consider it a good buying opportunity with a long-term outlook.

In the long-term, I strongly believe the shift to online sales direct to consumer is not a fad, it’s a secular change in consumer purchasing behavior which is changing the way businesses sell their products. The change in consumer purchasing behavior applies to auto sales and is evident by observing Carvana’s per market unit sales performance. I see tremendous growth potential in online auto sales and Carvana has a significant lead over its competitors. While not blind to Carvana’s lack of profitability, I’m encouraged by the observable and justifiable improvements in key performance metrics during their growth phase. For all of the reasons stated in this article, I believe that Carvana represents the evolution of auto sales and will be around for many years to come.

These are my opinions and the content contained in or made available through this article is not intended to and does not constitute investment advice. Your use of the information or materials linked from this article is at your own risk.