The bull-bear debate on Carvana
Wow, I've stumbled into quite the bull-bear debate on used-car retailer Carvana (CVNA)...
In Friday's e-mail, I shared links to four bearish reports from some of the smartest short sellers I know. Based on the bear case, I said I was adding Carvana to my "Stinky Six" list of stocks to avoid.
And yesterday, I reviewed the company's historical financials and nosebleed valuation: 93.4 times this year's earnings per share and 65.1 times next year's.
But there's a bull case for the stock, even at today's price...
As reader Todd N. said in an e-mail:
It's too easy to only look at the bear case for Carvana. To be more fair and balanced, I recommend you also consider the views of those who are long the stock. For instance, here's an interview the Yet Another Value Podcast did seven months ago with Cliff Sosin of CAS Investment Partners...
Around the same time, Patrick O'Shaughnessy did a two-hour interview with Sosin, which you can listen to on YouTube, Apple Podcasts, or Spotify.
Todd also responded to some elements of the short thesis – starting with the claim that there are problems with the subprime auto loans Carvana is making and securitizing:
The claim about subprime loans deteriorating is simply untrue. Pull up a securitization yourself on Bloomberg and look at it. CUSIP 14076LAE3 was issued in December 2024. This is the first subordinated tranche of the deal, so not a senior tranche, but a tranche that might actually have losses if the credit deteriorates. Today it is trading at a tighter spread to when it was issued, and is priced at ~102 which is greater than par value. Furthermore the credit support for this bond has improved since issuance.
All of this says the bonds are performing well and generally aligned with expectations. Of course there are losses on a subprime book of loans, but the important point is that the bonds were properly priced for those expected losses and performance so far is in line with the expectations. Losses would only be a problem if they significantly exceeded the expected numbers and so far they clearly do not.
Meanwhile, Todd took issue with a claim about Carvana's phony gain-on-sale accounting:
The comment about gain on loan sale being 93% of net income is not a fair comparison. The better comparison is to total revenue. $878 million gain on sale income is only about 6% of total revenue of $14.7 billion, so it's hard to call that a major threat to the company if it ceases.
Lastly, Todd addressed valuation:
I agree that valuation is a significant concern today given its huge gains. For anyone that holds the stock, I would consider taking some profits. And while the stock very well might have a pullback, I don't believe the company is a fraud – and the stock is not a zero. I would be ready to buy if there is any significant decline in the stock.
But even holding the stock might not be a bad idea. Reasonable growth assumptions for the company result in a price-to-earnings ratio of 30-40x in about 3-4 years. That's not ridiculous. Companies that are transforming an industry will always look overvalued in the early days. 10 years from now the story might be very different.
Thanks for your comments, Todd!
Another smart investor who has owned the stock for years is my friend Rob Vinall of RV Capital, whom I visited at his home in Switzerland in July...
Rob has an incredible track record, generating a 1,201% return for his investors since his fund's inception in the fourth quarter of 2008 through the first half of this year.
He invests the way I wish I had when I was running my hedge funds: long-only, with two-thirds of his capital in only five stocks – including one of my favorites, Meta Platforms (META) – each held for four to 10 years.
So it definitely caught my attention when I read in Rob's latest investor letter (which requires free registration) that Carvana is his largest position, accounting for slightly more than 20% of his fund.
He bought the stock (after Sosin told him about it) too early, in 2021 (discussed in his annual letter that year)... rode it way down... bought more... and held on as it soared nearly 130 times from the lows. (What a great example of the power of one of the most important requirements of long-term investment success: letting your winners run.)
Rob discussed Carvana at length in his latest letter, which he posted on August 30. Here's an excerpt:
When I initially bought our stake in Carvana, it was based on the hypothesis that its value proposition was so superior to the traditional used car dealer – in terms of price, selection and convenience – and that its business would be so difficult to replicate, that it would become not only the dominant used car retailer in the US but the dominant way that people purchase used cars. This remains my conviction today. The most significant difference between then and now is that whilst my conviction then was based upon a hypothesis, that hypothesis has now largely played out.
Today, Carvana is the most profitable used car retailer in the US, with an [earnings before interest, taxes, depreciation, and amortization ("EBITDA")] margin of 11%, nearly double its most efficient peers. It has infrastructure in place to retail 3 million cars p.a., which would take it to approximately 8% market share. Of course, there is plenty still to do to get from the roughly 600 thousand cars it will retail this year to 3 million. However, in contrast to 2021, all the pieces of the jigsaw puzzle are in place. The game is Carvana's to lose.
Rob acknowledged that the valuation is "no longer as attractive as it was at the depths of the crisis. That was likely a generational opportunity." But he said that "Carvana is still at an early stage of development, and I am convinced the upside outweighs the downside."
Here's more from his letter:
In terms of valuation, it should generate around $3 bn EBITDA in 2026. Much of this EBITDA will convert directly to cash, as it has little capex requirement, it is deleveraging rapidly, and it enjoys tax loss carry forwards. The EV to EBITDA multiple is around 25x – a high level but not inconsistent with many of the most highly sought-after businesses. In contrast to those businesses, though, Carvana should double its volumes every two to three years for a long time to come.
Lastly, he addressed the short case:
Despite or perhaps because of Carvana's recent history, there continues to be significant [skepticism] about its business model and the people running it. I disagree vehemently. I am convinced by the character and the motivation of Ernie Garcia, the company's founder, and the team of people he has collected around him. I wrote in the midst of the crisis in my H1 2022 letter:
As Carvana's woes deepened, I read much negative commentary about Ernie. I firmly disagree with it and would do even if the company were to announce its bankruptcy tomorrow. He strikes me as a decent person who is completely dedicated to the company he founded. If Carvana fails, it will not be due to duplicity or want of trying on his part.
Given everything that has happened subsequently – how the management stuck with the company during the crisis and ultimately emerged from it stronger – I would repeat that conviction and argue that it is a proven fact.
I tip my hat to Rob (and Cliff Sosin) for not only investing in – but having the courage and conviction to stick with – what has become one of the greatest turnarounds of all time.
But I'm leaving Carvana on my list of stocks to avoid.
In addition to the extreme valuation, I see too many warning flags.
I heard from two people that Carvana may be substantially overpaying for used cars (presumably to fill its securitizations and keep the growth story going).
First, as reader Peter M. said in an e-mail:
I had breakfast on Saturday with some friends, including a former car dealer (family owned for many years). I asked what he thought about Carvana and he replied that when they owned the dealership, Carvana bought a lot of cars at auction from them, but they bid too high more often than not, paying too much for their inventory.
And as Peter Bortel, who runs the Tiburon Opportunity Fund (incidentally, the source for the best short of my career more than a decade ago – Lumber Liquidators), told me in a text message:
We are short CVNA in part because of what I saw when I sold my old Tesla to them and bought a newer one.
The Blue Book price on my old car was $18,500. Tesla (TSLA) offered me $16,500, but Carvana bought it at $21,500.
When I looked [at] replacing it with a Model Y, a new one from Tesla was $56,000, but instead I bought an almost-new one-year-old one with only 2,500 miles for $36,500.
Based on this overpaying/undercharging, I believe Carvana's margins are impossible. They don't seem real based on market values.
As Peter added:
Delivery was a complete disaster. The driver was very inexperienced and couldn't get the ramp down, so I built one with bricks and wood. Then he was stuck on my street all day as he couldn't drive it or take my old car away.
I can't prove it, but it feels like Carvana is really stretching to grow fast enough to justify its valuation... which often ends very badly.
It reminds me of when real estate website Zillow (ZG) launched an "iBuying" program, through which it purchased and then sold homes, rather than just acting as a broker and taking a commission.
For a while, this juiced the stock, which quadrupled in less than a year starting in early 2020. But it turned out (surprise!) that Zillow was overpaying – and the stock collapsed. Take a look at this 10-year chart:
Lastly, here's a funny story...
Famed short seller Marc Cohodes was on the Value Hive Podcast on July 15, 2022 with Sosin, when Carvana's stock closed at $21.25 per share.
Sosin laid out the bull case on Carvana and said he thought the stock could hit $500 per share within five to six years, to which Cohodes replied that if that happens, "I will serve you guys breakfast, lunch, and dinner wearing a dress" and "will buy you [a vintage Ford] Cobra" (audio clip here).
CVNA shares recently hit $485.33 intraday and closed yesterday at $447.92, so Sosin might win this bet!
The last time I can recall so many investors I respect on opposite sides of a stock, it was when pharma company Valeant – now Bausch Health (BHC) – championed by my friend Bill Ackman of Pershing Square, peaked at more than $250 per share in 2015.
Short sellers like Jim Chanos and Andrew Left took aim at the stock – and were fully vindicated when it fell to less than $10 per share within two years. (It has never recovered to anywhere remotely near those old highs – closing yesterday at $6.91 per share.)
Buyer beware...
Best regards,
Whitney
P.S. I welcome your feedback – send me an e-mail by clicking here.
P.P.S. In yesterday's e-mail, I mentioned that I'm visiting my parents in Kenya for the holidays – which led some readers to ask why they retired here...
To repeat what I wrote in my September 30 e-mail, my parents met and married in the Peace Corps in the Philippines in 1962 and spent most of their careers in international development.
My dad's specialty was U.S. government-funded educational projects – teacher training, curriculum development, etc. – in developing countries. That's why I spent more than half my childhood in Tanzania (ages 2 to 5) and Nicaragua (ages 8 to 11).
After returning to the U.S. for my sister's and my teenage years, my parents moved back to Africa 30 years ago for the last two projects my dad worked on: eight years in Ethiopia and eight years in South Sudan.
For the latter, my parents were based in Kenya. There, they bought a lovely house outside the capital, Nairobi. And they built a barn for their horses, which you can see in the left of this picture:
Here's a picture of me in front of their house with my wife, Susan, my parents, my sister, and her son:
My parents enjoy life in Kenya (with two to three months spent in the U.S. in the summer). So when my dad decided to retire, my parents stayed there. (They maintained their U.S. citizenship, but have permanent-resident status in Kenya.)