RECAP OF LAST WEEK:
Last week we spoke about how it would retract from its explosive run on the FAA news from $50 mark this week and traveled to a low of $43.25 before returning around $45.20 a share. We have had a high accuracy covering this stock, however in the short term it is always hard to predict. In this case we saw that there would most likely be profit taking as the stock had over doubled within a month. (We mentioned that it should be a buy when it was $23 a share.)
IN THIS ISSUE
This used car e-commerce delivery company is extremely overbought and has a shocking amount of insider selling. Every day for the past month the CEO has been selling an average of $18 Million a day in stock or around 60,000 shares. Compared to their competition they are the leaders, however are trading at extreme valuations. We believe their next earnings report in August will crash the stock greatly if no growth is shown. We think it could crash from $312 to below $220 a share in a brief time period. Details on when it will crash below and how you could profit.
This company buys used cars and sells them at higher prices and delivers them to the customer. They have other aspects to the business such as financing loans for the used cars they sell to the consumer. All of the transactions are done through their website so the customer can receive their car in a few days to test drive and see if they like it. They have 7 days to return the car if it is not what they wanted. In their last report, they stated that they had achieved a revenue of $2.5 billion dollars. They also mentioned that they are expanding as well which is why they are not profitable. Carvana has appreciated 11 times the amount it was worth during the pandemic lows. From $29 now to $312.
Currently, the company is in the best market condition possible for their business. People moved to digital, used car prices have skyrocketed, and online demand is strong. They have been unable to create a profitable quarter in their entire existence. People are comparing this to an Amazon where they didn’t achieve profit and reinvested into themselves to scale their business but in our opinion Amazon has a much wider moat and better margin on delivering products. They also assume much less risk than Carvana because car prices can vary greatly. Right now it is looking good for Carvana because of the high inflation rate for all products but we are starting to see the stock market and bond market show deflationary reactions after this last job report. Deflation will cause car prices to drop heavily. The largest contributing factor to the increase in used car prices is the lack of GPUs (circuit cards) which have constrained the available supply of new cars. Consumers are unable to buy the new cars because of the extreme prices that these cars are being sold for. This has led to a boom in used car sales. We are watching for a dip in used car prices to pull the trigger on buying puts or call credit spreads. Also another method is to short sell the company as well.
Carvana’s business model relies on the buying of used cars and selling at a higher price to the consumer. The problem with this business model is that they have been buying a substantial amount of high priced used cars. If the price of these used cars drops drastically, Carvana will have to sell the cars at a loss. We think this will be the first domino to strike the stock price lower. Here is their plans on inventory and as talked about they are increasing the inventory they have while used cars are at extremely high prices.
This is their inventory reported during the 2021 Q1 report. They are expecting to almost double it. If used car prices sink, the company will be under much financial stress since they have bought used cars at higher than average prices.
The chart below shows gross profit per unit. Not a good sign because it is not net profit. This means they possibly could be selling at a loss per unit and this is in the best market environment. We expect the gross profit per unit to start dipping after August. The company keeps telling investors that they expect higher margins per unit as they reach a higher scale, however we are very concerned that they are misleading investors.
Gross Unit Profit Per Car: (not showing associated losses per car which is more than they are selling them for)
The financial statement chart below shows the net losses over the years. As you can see in the best market conditions, they still have maintained losses. We would have expected them to achieve near profitability.
Financial Annual Loss Statement from Carvana:
Financial Quarterly Losses for 2020 and 2021:
The last quarter they still were unable to achieve profitability. These are the cracks we are seeing before the business suffers from deflationary pressures in used cars.
Here are some other red flags we have found that this company has:
One family of the business controls most of the shares. The CEO's son (Garcia II) had bank fraud criminal activity and served a 3 year probation in 1990.
The CEO and his family are also in a lawsuit currently on insider trading during the pandemic market crash knowing that their business was not impacted and buying shares without disclosing that they were not impacted.
The CEO has had the same type of business before and it IPO'd as "The Ugly Duckling," on the IPO they traded at $25 a share but 3 years later could not run a sustainable business and it crashed to $2.5 a share.
Every 1-2 business days for MONTHS, Garcia II (the son) has been selling $18 MILLION worth of shares. This is not usual behavior. Especially since Garcia II has had a criminal past. We think that there may be something going on here as it seems the son is being used to funnel money out of the business while it's at extreme valuations.
They have been unable to attain a sustainable business even in the best market conditions for ecommerce and used car sales.
They are trading around 25 times above their annual revenue from last year (best possible market conditions) and are promising to be sustainable once they reach scale. However, in my opinion this is not an easy business to become profitable especially since they have not been profitable in the most explosive environment for used cars.
Every quarter they report over 80+ million in losses, some quarters have reached 384 million like in 2019.
They are trying to buy up used car inventory right now as the prices of used cars are skyrocketing. We think the prices will come down quickly as demand dries up which will force the company to sell all of their inventory at a loss.
Their competition (CarLotz and others) are currently trading at less than 1 billion market caps. You could definitely argue against me here since Carvana has the brand name, but this is usually a good reference to see how sky high this company is trading at the moment.
We expect a mild dip on deflationary news for this company, however we do think they may beat their Q2 August earnings report. Shortly after though the stock price may suffer as the market environment starts to change.
Current Price: $312
One Month Target: $290
Two Month Target (after their earnings report in early August): $275
They could possibly go up more after this earnings if Carvana reports higher than expected revenue, but we think this company will be under large scrutiny if they ever miss in growth. We think they will crash at some point after this earnings.
Six Month Target: $120
Final Thought: We think they will beat their August earnings due to the high used car prices at the moment. Even if they beat the earnings, I think investors will eventually turn their eyes towards the sustainability problems facing the company in the future.
Disclosure: We do not hold any Carvana securities/shares at the time of publication.
All stocks talked about we have invested in, and do not intend to give advice nor recommend acting upon the information.
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Until next week,
and the Optifinancial Team
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