Carvana's Turnaround Could Be Just Beginning

The used car specialist has further avenues for growth.

Carvana‘s (CVNA -4.81%) shares soared 34% in the wake of its first-quarter earnings report on May 1, resulting in a year-to-date gain of 130% as of market close May 6. The stock has been an absolute rocket ship this past year and is up 3,100% from its early December 2022 low.

Investors who were down on the stock likely believed the company was just another tech meme boosted by the pandemic and expected it to fail along with the collapse of the used car market. Carvana became the most hated stock in the market, with the highest short ratio of 88% in 2023.

But Carvana brought significant value to retail customers with its online shopping approach. Car buyers are fed up with the lack of price transparency at dealerships, and Carvana stands out as the only company offering a simple one-click transaction process along with an industry-leading seven-day free-return policy.

Despite operating on a smaller scale, Carvana showed that it can outperform used car specialists like CarMax and AutoNation in terms of gross margin and gross profit per unit. That success is due to its online e-commerce platform, which allows it to acquire the majority of its inventory directly from customers, keeping costs low compared with traditional dealerships. Additionally, because shoppers value the ease Carvana offers, it was able to make more money on loans than its competitors.

Carvana has proven that it can increase profitability and unit economics even in the face of a drop in used car sales. As a result, through a series of negotiations with debt holders, management was able to successfully steer the company out of its 2023 slump and optimize its operations.

What should excite investors the most is that Carvana’s industry-leading profitability should allow it to transition into a more lucrative marketplace business model. After acquiring ADESA’s U.S. physical auction business in 2022, Carvana became the second-largest used car company in the U.S.

This move provided a solid foundation for Carvana to grow its fee-based used car marketplace, which offers much higher profit margins compared to its retail used car business. For example, Copart‘s focus on higher-margin marketplace strategies allows it to be valued nearly 3 times higher than Carvana, even despite selling fewer units. Carvana is already seeing remarkable success in this area, with marketplace revenue increasing 74% and gross profits skyrocketing 290% in 2023.

The marketplace business is poised to become one of the company’s primary profit drivers in the long run. I think Carvana’s revival may be just beginning.

Yun Chung Lee has positions in Carvana. The Motley Fool has positions in and recommends CarMax. The Motley Fool recommends Copart. The Motley Fool has a disclosure policy.

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