Chapter 1: Overview of Carvana's Situation

Carvana finds itself in a precarious position. With its stock plummeting 86.3% this year, while broader market factors play a role, disappointing Q1 results have driven many investors away.

For those who may not know, Carvana is a leading online platform for buying and selling used cars. To simplify, the company purchases pre-owned vehicles, refurbishes them, and then resells them at a profit. Additionally, they earn revenue through vehicle financing and services like gap waivers and service contracts, outpacing many competitors in these areas.

Given this context, gross profit becomes a more significant metric than revenue, with Gross Profit per Unit (GPU) being essential for dealers like Carvana. This figure illustrates how much profit the company earns from each car sold.

In the last quarter, Carvana's retail GPU dropped sharply, while Selling, General, & Administrative (SG&A) expenses soared. GPU fell from $4,566 in Q4 2021 to $2,833 in Q1 2022, with SG&A rising from $620 million to $727 million — equating to an increase from $5,486 to $6,912 per unit.

In essence, Carvana struggled to maintain its profit margin on each car sold, with rising overhead costs compounding the issue.

The main reasons for these challenges include macroeconomic pressures such as Omicron, fluctuations in used vehicle prices, and increased interest rates. On a more operational level, management highlighted disruptions in reconditioning and logistics networks.

Here’s a snippet from the company’s letter to shareholders:

Retail GPU was affected by an over $600 per unit rise in reconditioning and inbound transport expenses compared to the previous year, coupled with a more than $100 per unit decline in shipping revenue due to customer refunds following extended delivery timelines. The increase in retail costs during Q1 stemmed mainly from inefficiencies in inspection and reconditioning facilities and logistics, exacerbated by Omicron, severe weather, and the prolonged recovery from these events.

They believe these Q1 challenges are temporary and anticipate a return to normalized retail costs as their logistics network stabilizes and expenses align better with sales volumes.

Furthermore, management noted:

We typically prepare for sales volume 6-12 months ahead, meaning we scaled our capacity for a significantly higher volume than we achieved in Q1. Given our costs are relatively fixed in the short term, lower retail unit sales resulted in higher costs per unit for goods sold (like reconditioning and inbound transport), leading to diminished GPU and elevated SG&A per unit. Rising interest rates and credit spreads also contributed to a lower EBITDA margin.

To address investor worries, the company unveiled a revised plan.

In summary, Carvana’s management is shifting focus from increasing GPU to optimizing infrastructure to achieve positive cash flow. Specifically, they plan to slash SG&A expenses, which has led to a significant workforce reduction. On the same day, 2,500 employees were laid off, with many informed via a pre-recorded Zoom meeting.

While this raises concerns about operational capabilities, Carvana argues that its workforce had grown disproportionately compared to sales volume — an increase of 1868% over five years.

Alongside the headcount reduction, management outlined various efficiency improvement strategies, including:

• Internal benchmarking to elevate overall employee performance to the standards of the top 20% of workers.
• Enhancing inventory visibility by addressing logistics constraints that hinder car listings, aiming to reduce rescheduling and delivery delays.
• Utilizing its recent $2.2 billion acquisition of ADESA, a physical car auction platform, to enhance processing capabilities and minimize transportation distances.
• Bringing back certain previously outsourced tasks, like title and registration processing.

Despite being a tech-driven firm, Carvana's sector remains far from streamlined in terms of operational efficiency.

How realistic is Carvana's updated business strategy?

The company aims to reduce its SG&A costs per unit from $4,780 to $3,000 annually. If they achieve 100,000 unit sales, this translates to a $300 million reduction in SG&A. However, in Q1 2022, Carvana's SG&A expenses were $727 million, necessitating a nearly 60% cut or a substantial increase in sales at the current overhead levels.

Carvana also shared a composite SG&A figure, which reflected the best quarters for each SG&A line item, totaling $3,891 per unit sold. To meet its FY23 target, they would need to lower each category by a collective $891 per unit, amounting to $89 million with 100,000 unit sales.

This, however, is an ideal scenario; the reality is likely more complex.

Is this achievable?

Let’s assess the company’s historical performance in this area over the past three years.

The most crucial takeaway is that while Carvana has almost tripled its retail unit sales, SG&A has risen faster than gross profit, save for one quarter in Q2 2021.

Over the last 13 quarters, SG&A has exceeded gross profit by at least 30% in seven instances, indicating significant cash burn, even when considering non-cash expenses like depreciation and stock compensation.

The final analysis offers a broader view of Carvana's ambitious operational turnaround.

While the company has approached profitability in the past year, challenges like supply chain disruptions and rising interest rates cast uncertainty over the used car market in the near term.

In any business endeavor, it’s often advisable to underpromise and overdeliver, setting expectations low to allow for pleasant surprises. Unfortunately, this situation seems to be the opposite. For the sake of Carvana's shareholders, let’s hope for a turnaround. As of Thursday, Carvana shares were priced at $32.88 — a notable drop from their peak of $376.83, though it may not yet represent the lowest point for this used car venture.

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Chapter 2: Carvana's Strategic Response

In the video titled "Carvana Not Focused on Growth, Leaked Rivian Release," the discussion revolves around Carvana's strategic shift and what it means for the future.

The second video, "Carvana Has a Major Problem !!!," delves deeper into the company's ongoing issues and potential solutions.