Taking a look at Carvana plus a cross read on Root (incl. Excel Workbook)

The used car market is poised for a rebound. Will Carvana be able to leverage the opportunity to increase market share and resume its mission to reinvent how we buy cars?

Disclaimer: The information contained in this article is not and should not be construed as investment advice. This is my investing journey and I simply share what I do and why I do that for educational and entertainment purposes.

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I kind of have a love & hate relationship with CVNA 0.00%↑. I liked the setup in early 2023 when they were at completely bombed out levels. Selling used cars is a huge market in the US with an annual turnover of about $350bn. Disrupting this industry through automation has huge potential.

But to have a shot at doing so, the company needed to fix their financials. I followed the company’s quarterly earnings releases and ultimately abstained from putting significant money into it because I was not entirely convinced the unit economics would work out for them. At least not quickly enough.

As of today, the stock is up 600% since the first tweet above. And it is even up 300% since the second tweet above when I concluded the opportunity had likely passed and decided to move on.

It is frustrating to see an opportunity passing by without taking advantage of it. The fear of missing out is strong in me. I fear ‘not trying’ much more than I fear ‘failing’. This makes me a natural risk taking personality which has served me well in some instances (for example when I bought TSLA 0.00%↑ in late 2019 which is the main reason I am even able today to send these emails to you at such a cadence and depth). And it destroyed me in others (let’s not go into the details here, I am sure you’ll find the skeletons in my closet if you take a closer look at the article archive).

Such frustration typically prevents me from looking into a stock again after I missed it. But since I recently found ROOT 0.00%↑ and took a pretty significant position in it, I feel like I have to understand Carvana as well. Both companies are fairly entangled. So, let’s take a look at Carvana. Still one of the most hated and most ridiculed companies out there.

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TLDR Summary

• I does not require much imagination to build a bear case for Carvana. This stock commands a $15bn market cap and $21bn Enterprise Value while operating in a stagnant low margin industry where neither their profitability nor their sustained ability to take market share has been proven. Such a valuation seems like a joke. One that fits in with their ridiculous anachronistic car vending machine towers. A relict of the ZIRP mania, right?

• At second glance, there are some interesting aspects though. The company has navigated a brutal used car market recession surprisingly well. Used car prices are down 20% from their peak and sales volumes are 30% below prepandemic levels. In spite of headwinds from falling prices and interest rate induced consumer strikes, they have almost completed fixing their financial statements. Their unit economics are starting to make sense and they have made progress deleveraging their balance sheet. This sets them up to continue their growth journey which is predicated on disrupting the used car market through a highly automated selling process.

• Going forward, there is cyclical upside in the used vehicle market, which is trailing the recovery in the new vehicle market significantly. While new car sales have started recovering in late 2022, used car selling volumes firmly remain close to a cyclical bottom. Pent-up demand is likely strong and pressure is building up in the system with every month that passes. A catalyst for a rebound may be either falling interest rates, continued falling vehicle prices or rising household incomes, any of which will help making used cars more affordable for consumers.

• The difficulty of making a bull case work from a valuation perspective results from uncertainty about where the company’s operating margins will settle. This uncertainty creates risk. But it also creates opportunity. Many market participants doubt the company’s ability to deliver on their bottom-line. Short interest stands at a pretty incredible 38% of the float. In absolute terms, fundamentals may not (yet) justify the valuation. But their trajectory clearly points into the right direction. A potentially toxic cocktail for shorts. And what if they turn profitable and become eligible for S&P inclusion? Then we may not have seen the real squeeze yet.

• Carvana is a health indicator for Root. It is an important sales channel for Root’s embedded insurance product and Carvana has a significant economic interest in Root through their convertible preferred stock and their warrants. Additionally, both companies are subject to similar economic risk factors. Rising turnover in used cars would fuel Carvana’s business for obvious reasons. And every time a consumer buys a new car, it creates an opportunity to switch their insurance. This is an important catalyst for a small player like Root that challenges incumbents.