Investor Dialogue: Carvana vs CarMax

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Disclaimer: This interview is for informational purposes only and should not be relied upon as a basis for investment decisions. In Practise is an independent publisher and all opinions expressed by guests are solely their own opinions and do not reflect the opinion of In Practise.

Firstly, how do you compare the model of used car dealers like CarMax or Carvana to the traditional dealers?

Analyst 1: Clearly, there are differences and I think one way to look at it is to say, okay, CarMax and Carvana focus on the used space which is much larger than the new space; they can get nice scale there. One of the things I like to look at, in terms of these businesses, to measure how well they are doing, is inventory turns. CarMax has higher inventory turns compared to every traditional dealer, except maybe for Asbury, who is approaching that. The way I look at it is, if you compare cars to a Costco model, the whole idea being, if you turn the inventory quicker, you can sell cars for a cheaper price and get the same ROE. You get the economy share by having that type of a system of flywheel set up.

One of the questions I’ve had about Carvana, for which I haven’t yet been able to come up with an answer is, their turns are significantly less than CarMax. They approached CarMax before recession and now they are going back down again. I’m trying to understand what is really going on there. Are they building this giant flywheel that there is no demand for? Can the other folks here bridge my lack of knowledge as to why Carvana has such low inventory turns versus the traditional internet ecommerce model, where the idea is, you do quicker turns, lower margins but you can split the difference with the customer.

Do you mean only for 2021, where it seems to tick down slightly?

Analyst 1: That’s right. They were approaching each other before 2020 and, in 2021, Carvana has gone down and CarMax has gone up. A lot of the other traditional guys have also gone up, but it’s fairly tough to tell as the traditional guys have new cars when there is shortages so you need to pull that out, so they don’t break out the inventory between the two. There is a car company, in China, that I think is probably one of the better ones in the world to study. Its inventory turns are 12X. I think turns are such a good metric because, in this business, you are matching people and cars. The higher the inventory turn, that means you are matching people and cars quicker and, therefore, everybody wins. That whole process of being able to combine the two, is what the objective here is. I’d love to hear other people’s thoughts on that?

Analyst 2: Can I just ask a quick clarifying question on that? Do they all account for inventory the same way or are there are differences? For example, if they just bought it and it’s being reconditioned, could it be in another balance sheet line item, or is it totally consistent across all the publics?

Analyst 1: I’m assuming, amongst the franchises, that it’s pretty consistent. I don’t know if there’s a difference between Carvana and CarMax, in terms of the way they would do it. It’s a good question and I don’t know the answer.

Analyst 2: I’m thinking of CarMax versus some of the others and I can imagine, if you are doing your own reconditioning, so a car is in your inventory, compared to buying a car from an auction, that the auction reconditioned, I wonder if that affects turns. I’m trying to imagine if the metric is strictly apples to apples, across all of them.

Analyst 3: If it’s just a recent thing, it could be just Covid and that kind of thing, where you had a lot of drivers out, potentially, and companies making some noise about that. If that’s the case, then it’s going to be a short-term thing. I don’t know that affected the last-mile delivery or if it affected their delivery, across country, to the reconditioning centers.

Analyst 1: The other company I’ve seen with high turns, in the UK, is Motorpoint. Again, that’s another one that has a high turns model. They have another reason, as well, which is that they are selling slightly used cars and the inventory falls in value very quickly, so they have a huge incentive to sell it very fast. In my mind, I’m thinking of this like a retailer. If you use the retailer model, in this perspective, I think it’s an interesting way to look at it.

That company, in China, that does 12X turns, it’s the highest one in the world. The guy writes an English annual report and it’s interesting to see the way they do stuff. I owned a company in the UK that was taken private, that had the highest turns amongst the UK companies, called Cambria, and you saw some of the stuff they would do, from a customer service perspective; you could tell that the salespeople were motivated to increase those turns.

Maybe the mix matters? As you said, Motorpoint, here in the UK, have the highest turns in the used space but they do nearly new cars. They are buying at the steepest part of the depreciation curve so they have to optimize their whole model, to sell the inventory quicker.

Analyst 4: On that point, one thing that I’ve been tinkering with and looking at closely, on Carvana, is the amount of inventory sourced from customers. That mix has increased dramatically over the last few years. I wonder if that results in slower turns because there is more product diversity. Maybe the IRC processing times are longer; maybe it’s compounded by labor and logistics issues. They said they bought their millionth car; they probably doubled the cumulative purchases in 2021, or in the last five quarters. They’re buying more than they are selling from retail customers and they’re sourcing the majority of their cars from retail customers, at this point. Maybe the mix has something to do with those slower turns?

Analyst 3: They’re also holding a lot more inventory. If you look at their year-end results, they’ve got three point something billion in inventory, versus about a billion for 2020, so they’ve really scaled up how much inventory they are buying and they are not selling quite as quickly, given the slowdown post Covid. But I think if you look at a longer-term trend, they’ve been improving.

Analyst 1: As you say, they actually approached CarMax before the recession and now they’ve come back down. I was just surprised by the fact that they didn’t keep on going up. I think, if the business model is really working, you would see it inflect up, but maybe there are some shorter-term reasons why not.

Analyst 2: I’m not saying this, necessarily, is my view, but I’m pretty confident I know that if Ernie Garcia were on this – I guess he wasn’t available – I’m pretty sure I’d know what he would say. I think the answer is, Carvana’s inventory is not really national. If I’m on the East Coast and the car I want to buy is in California, yes, it’s free delivery, but they have every incentive to do everything they can for me not to buy that because it will not be a very profitable sale for them. What they really need is to have regional inventory. I know their belief is that they need to scale up everywhere. They need to have 25 Toyota Camrys, in every region, not just have 50 of them nationally, for the business to work.

They would say, you have to build the inventory and build the scale to maximize, not all the cars that I can buy that are anywhere in America, but all the cars that are close enough to me, that they can fulfil the order quickly and cost effectively. I think their answer to this question would be, we have to build the inventory regionally, before we can offer the customer experience that we want to be able to offer, at the economics we want to be able to offer.

Analyst 4: Are you saying that that implies that the new market additions that they have added over the last 12 to 18 months are scaling up slower because they don’t have as much local inventory that is relevant to the buyers there, so those are driving down the average? Presumably, the more mature markets should be increasing their turn rate, over time, if the penetration rates continue to rise. Is that the implication or is it something else?

Analyst 2: I think that’s, basically, it. That is my relatively confident guess at how they would answer the question. My personal view is, the used car market has just been so crazy and weird for the last 12 to 18 months, that all these companies are doing everything they can to increase inventory. CarMax and Carvana both say that on every call. They feel as if they are way below where they should be and they are doing everything they can to increase it. If you could give specific numbers, over what timeframe and how big the decrease is, that would be helpful.

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