Integrating ADESA Mega Sites Will Offset Rising Lending Risk

Key Takeaways

• Limited ADESA site openings and aggressive inventory could constrain sales growth and impact margins if demand falls short.
  
• Rising interest rates and reliance on equity offerings may hurt Carvana's margins and earnings due to financing pressures and shareholder dilution.
  
• Strategic expansion and enhanced operational efficiency position Carvana for growth, leveraging strong liquidity, AI, and increased capacity for potential revenue boosts.

Catalysts

Operates an e-commerce platform for buying and selling used cars in the United States.

• Carvana's expectation to open fewer ADESA mega sites than projected could lead to lower capacity expansion and limit retail unit sales growth, potentially impacting future revenue targets.
  
• Increasing interest rates and unpredictable securitization markets may put upward pressure on lending rates, impacting Carvana's financing arm and possibly compressing net margins as consumer financing becomes less attractive.
  
• Despite claims of operational efficiency, any delay in achieving these fundamental gains and integrating new sites could result in higher-than-expected SG&A expenses, negatively affecting earnings growth.
  
• The company’s focus on maintaining market share through aggressive inventory expansion could lead to higher depreciation costs if demand does not scale accordingly, ultimately impacting net margins.
  
• Continued reliance on ATM equity offerings and significant debt could lead to shareholder dilution, affecting EPS growth and reflecting operational challenges in achieving investment-grade credit ratings.

Carvana Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Carvana compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Carvana's revenue will grow by 17.3% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 2.7% today to 4.2% in 3 years time.
• The bearish analysts expect earnings to reach $1.0 billion (and earnings per share of $5.01) by about July 2028, up from $398.0 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 74.9x on those 2028 earnings, down from 116.4x today. This future PE is greater than the current PE for the US Specialty Retail industry at 17.6x.
• Analysts expect the number of shares outstanding to grow by 7.0% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.83%, as per the Simply Wall St company report.

Carvana Future Earnings Per Share Growth

Risks

• Carvana's integration of ADESA mega sites to increase capacity up to 8x of current volume could drive significant revenue growth by allowing the company to scale operations efficiently.
  
• The company's low nationwide market share of 1% suggests significant room for growth in capturing market share, which could result in increased revenue and net income over time.
  
• Carvana's improved operational efficiency and reduced costs per unit, as seen in their adjusted EBITDA margin of 10.1% and decrease in SG&A per retail unit sold, indicate potential for sustained profit margins.
  
• With over $1.7 billion in cash and $3.6 billion in committed liquidity resources, Carvana's strong liquidity position allows it to potentially leverage growth opportunities, impacting future earnings positively.
  
• The use of AI to enhance customer experience and operational processes could lead to improvements in customer acquisition and retention, potentially boosting revenues and net margins through increased sales and improved efficiency.

Valuation

• The assumed bearish price target for Carvana is $230.0, which represents the lowest price target estimate amongst analysts. This valuation is based on what can be assumed as the expectations of Carvana's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $415.0, and the most bearish reporting a price target of just $230.0.
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be $23.9 billion, earnings will come to $1.0 billion, and it would be trading on a PE ratio of 74.9x, assuming you use a discount rate of 7.8%.
• Given the current share price of $343.0, the bearish analyst price target of $230.0 is 49.1% lower. Despite analysts expecting the underlying buisness to improve, they seem to believe the market's expectations are too high.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.