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Carvana V. Vroom - Revisit Post Earnings

Joshua Chapter 1 verse 9 states, "Have I not commanded you? Be strong and courageous. Do not be afraid; do not be discouraged, for the Lord your God will be with you wherever you go."


Life is full of things that can lead to fear or worrying concerns. However, as a Christian, I am taught to be strong and courageous and to not be afraid. This isn't because of any reason other than the fact that Jesus Christ has conquered death through His resurrection. In addition and concurrent to Jesus paying the price for my sins, God commands me to abide by His words, to trust Him, as He is with me.


If only it were this simple with respect to investing right? Well, in my book it is. Over the last one hundred years, there have been plenty of corrections, recessions, depressions, and volatile and stagnant market periods. There is nothing new under the sun. To be invested in equities requires a strong sense of courage and most importantly conviction. And of course emotions will be impacted during times like we are facing today. But if there isn't a similar principle to abide by as God's command, there is no way I will be able to execute and make decisions in the best interests of what I am managing.


Both companies, Carvana, Inc. (CVNA) and Vroom, Inc. (VRM) reported their earnings results with stark contrasts in how the SPs performed immediately following. CVNA shot up by over 20%, while VRM was crushed by negative 45%. Since VRM's debacle, CVNA has dropped by 33%, granted that market turmoil continues to add pressure to the downside for all growth-oriented companies.


I was bullish on VRM, primarily for the fact that the fragmented nature of the market could afford multiple E-commerce based competitors. I will admit that I've always considered CVNA to be the clear leader and have wrestled between the two since both went public. VRM's extreme relative discount has always been a core factor in the opportunity. After considering VRM's results, I liquidated the entire position based on the substantially lowered guidance, and the fact that CVNA's acquisition of ADESA could prove problematic for VRM's reconditioning capacity, a key driver for volume growth. Fortunately, I liquidated in after-hours this past Monday avoiding further massive losses throughout the week.


Initially I considered deploying proceeds into CVNA. But after assessing both of these companies more rigorously, I have come to the conclusion that neither is worthy of investment at this time.


VRM

The key items to focus on with the information above are financial strength, valuation, and GM and Adjusted FCF Margin. For both VRM and CRVNA, the trick is to off-set each company's respective Used Vehicle Inventory against their Vehicle Floorplan financing. This is similar to how Opendoor Technologies, Inc. (OPEN) uses Non-Recourse Asset-Backed Debt to fund its Real Estate Inventory. The commonality here is that these companies are using a specific form of debt to fund the core driver for their Revenue growth. This is different from a company using debt to fund capital improvements related to Property, Plant, and Equipment, PPE that typically add capacity to grow Revenue from product development or a manufacturing standpoint. There is a strong correlation for economic cycles as demand increases, debt will need to grow to purchase inventory and vice versa.


The key here is that while a company like OPEN needs to use financing to purchase Real Estate Inventory, both VRM and CVNA also need to invest substantially into Capex to grow their reconditioning business needs as a key driver to turn vehicles over quickly, including delivery and logistics investments for a direct-to-consumer model. These reflect two big capital intensive, and in VRM's case, third-party service needs that OPEN does not have. Real estate does not need to be transported, either to a reconditioning center or to a consumer.


All that being said, VRM is in a somewhat stable financial position in that at the end of 2021, the company had Net Cash of over $520 million. From a valuation perspective, VRM is currently trading .1 times EV/Revenue which is insane as the company's Revenue growth is robust. From a GM and Adjusted FCF Margin perspective, the company has witnessed GM remain mostly flat and lower from 2018 levels, and has burned cash just below 13% greater than Revenue generated.

As noted above, VRM's Revenue has grown from $855 million in 2018 to $3.2 billion as of 2021. It is concerning that the GM has declined from north of 7% to just above 6% during this growth phase. Additionally, Adjusted FCF has continued to increase as well, with 2021 seeing negative $400 million in Cash Burn. Looking back at VRM's Net Cash position of over $520 million and the company will definitely need a Cash raise sooner than later in 2022.


With the substantial collapse in SP, VRM is going to need to take on more debt, most likely $1 billion or more to instill confidence for investors over the next couple of years. VRM's GM and Adjusted FCF margins are much lower than CVNA's, so even as VRM scales (as the company is far behind), it will continue to burn cash at a high rate.

I'm not going to spend much time here on VRM's segment and metric breakdowns. As will be seen below, VRM is substantially lower on all of these with respect to CVNA, who's scale is much larger. The key metric to pay attention to is Total Gross Profit per Unit. When comparing apples-to-apples, CVNA is only slightly ahead of VRM, but as can be seen from financial margins, VRM is struggling much more than CVNA, which suggests that something isn't right from VRM's reporting.

With respect to forecasting VRM's potential, it needs to be clear that the high-level financial model results above assume that VRM can continue to sustain it's business and grow, albeit at a slower rate. The key issue here is CVNA's deal for ADESA, which does impact VRM's capacity to recondition its used vehicles for sale.


As some may know, VRM uses an asset-light approach that includes direct investment into reconditioning centers, and third-party capacity. Typically, VRM has explained that it will take a moderate approach to eventually build a majority-based reconditioning center capacity, in order to rely less on third-party providers. ADESA is one of VRM's third-party providers that will no longer be available. VRM mentioned this on their presentation as an area that needs to be assessed.


If VRM is able to sustain itself and grow north of $10 billion in Revenue over the next five years, the SP likely will reward investors handsomely. However, VRM will still be at a point below where CVNA is today, equating to a substantial need for capital for this to pan out. This is the major concern right now as VRM is much further behind the curve.


CVNA

Looking at CVNA for the same key metrics and the company is clearly outperforming VRM with a much larger scale for its business. This has afforded CVNA with a substantial premium EV/Revenue valuation multiple at nearly 2 times, versus VRM's paltry .1 times. CVNA's GM is more than double that of VRM at 15%, while Adjusted FCF Margin is also performing better, albeit still negative by a strong margin.


The core issue I have with CVNA is its financial strength. Prior to the ADESA deal announcement, CVNA's Net Debt stood at over $1.6 billion versus VRM's Net Cash position, north of $520 million. With the announcement of the deal for ADESA, CVNA will be raising further debt of $3.3 billion to finance the acquisition and invest another $1 billion into the newly acquired reconditioning centers. This all will increase the Net Debt position towards $5 billion. CVNA only has $400 million in Cash available, and will likely need to raise more debt sooner than later, just like VRM.

The good news for CVNA is that the company has seen an improvement for Adjusted FCF Margin as Revenues have continued to scale further. Gross Profit stands at $2 billion and negative Adjusted FCF has dropped by 25% from the peak in 2020. Clearly, CVNA's much more capital intensive business model is evident as the company invested over $550 million in Capex versus VRM's less than $30 million. This is also evident form VRM's less than $40 million in PPE versus CVNA's nearly $1.6 billion.


CVNA's Revenue is 4 times that of VRM. Looking at the lead that CVNA has on VRM and VRM's most recent discussion of their business, and it is my opinion that CVNA is the clear leader and that VRM will be playing catch-up indefinitely. This is one reason why I sold VRM as management has seemingly taken a much more conservative approach versus taking the risk that was required to compete stronger within the market opportunity.

Similar to VRM, I'm not going to spend much time here for CVNA. They are focused on penetration and access for the U.S. population which makes sense, as is VRM. Again, their scale is reflective of their Revenue performance against VRM for all of these metrics, notably, their Unit Sales Information.

The distinction with respect to my high-level financial model is that CVNA had a much better year against my estimates for 2021 than VRM did. And while both companies beat Revenue estimates, CVNA displayed much better unit economics across the board, which has been a consistent trend over the past few years. VRM was always the anticipated stronger growth play for the future, this has become more questionable.


Conclusion


Coming into 2022, CVNA has also displayed much better guidance with respect to previously assumed estimates. VRM guided significantly lower for Q1 2022 (by 16% for Revenue) and did not provide full-year guidance. I feel that CVNA is in a much better position to achieve its mid-term goals and objectives and has a much better shot at growing north of $40 billion in Revenue, than VRM does at the moment of exceeding the $10 billion level.


Even if VRM is successful in sustaining itself, it will still be at a disadvantage with respect to being below where CVNA is today and dealing with the same Cash Burn issues year-in and out. While I am more confident in CVNA, I did not decide to take a position in the company. I did consider redeploying the entire liquidated amount into CVNA, but I cannot get over the fact that the company will be approaching a Net Debt position of $5 billion, and likely still need to raise more capital to grow the business. I see Net Debt continuing to increase over the short-term, possibly towards $7 billion or higher.


There is no gaurantee that CVNA will indeed be seeing a positive Adjusted FCF Margin until later towards 2025, if at all. I could be a little to strict here, but not many of the companies I hold have Net Debt. The few that do, are on a clear path towards Net Cash. As we continue to go through substantial market volatility and uncertainty, companies with strong Cash positions and growing businesses will come out much better than slower-growth and higher leveraged peers across all sectors. While both CVNA and VRM are targeting long-term high-growth markets, there is not any indication that either is close to turning the corner with respect to Adjusted FCF.






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