Used cars: 'There's a rich debate' over Carvana earnings, analyst says

RBC Capital Markets Internet Analyst Brad Erickson joins Yahoo Finance Live to discuss Carvana earnings as well as the outlook for the used car market and e-commerce.

Video Transcript

BRAD SMITH: Welcome back, everyone. Online car dealer Carvana is no doubt one of the pandemic's darlings, reaching 52-week highs, over $300-- $370 a share. But like many in the auto industry, they have been ravaged by supply chain disruptions, and the company has done nothing but slide in 2022. Joining us now for more on Carvana is Brad Erickson, RBC Capital Markets internet analyst. And Brad, particularly here, we also got to address, they just can't possibly sustain the type of retail units sold, especially not at the used car prices that we're seeing right now.

BRAD ERICKSON: That's right. That's right. Yeah, for years, these guys had grown north of 100% a year for many years. Company's only been around since 2012, but had sustained high growth for a long, long time. And then, yeah, obviously, over the last year or two, initially, after the pandemic slowdown, they saw sort of a re-acceleration.

But obviously, as we've seen with chip shortages, car shortages-- car manufacturing shortages, and subsequently, used car and wholesale inventory shortages, prices have skyrocketed, interest rates have gone up, affordability has gone down, and now unit growth in the market is actually down double digits year over year, as we start out this year. And that's just made for a very tough environment for even the online retailers like Carvana.

BRIAN SOZZI: Brad, do you see Carvana as a true disruptive force in auto retailing, like Amazon has been in brick and mortar retail?

BRAD ERICKSON: Conceptually, yes. I think the question here, though, is, there's a $40 million a year unit market in used car dealers. These guys are doing about 530,000, 540,000 cars this year, so very, very low penetration. And I think if you're on the camp of these guys are the Amazon of that category, it goes from a little over 1% share today to 10% share over time. I think there's a question in a lot of investors' minds as to how high penetration can actually go for pure online car sales. I think there's no debate that it can go significantly higher.

But again, when your growth is slowing down to the teens, 20%, even 30% when you're 1% penetrated, I think that calls into question as to whether they can truly become Amazon, where, for context, you know, e-commerce of consumer retail is over 20% penetrated 20 years in. So, yeah, I think there's a rich debate to be had around that.

JULIE HYMAN: And Brad, it's Julie here. What about the credibility of Carvana at this point? You know, I know that they've come out with this ambitious plan, which maybe reassured some investors, but the stock's down again today. So I just, kind of to your point, even if this market, in theory, exists, is this the team that can even take best advantage of that?

BRAD ERICKSON: Yeah, I think with what's going on with the stock right now probably has less to do with the overall market per se in whether a native digital car dealer can disrupt the industry, and more about Carvana unique issues. What's happened here is they've been growing very, very fast. And in order to maintain that growth, they have to expand capacity. Well, a quarter ago, what they did was they went out and bought this company called Odessa, which is the second largest wholesale channel in the United States.

And the intent of that acquisition was to basically triple their capacity, almost triple their capacity, from where their current plans lay. And they felt that it would obviously accelerate that capacity expansion and allow for significantly faster unit growth over time. That's all well and good.

The problem is, is the company was stacking $5, $6, $7, $8 billion of debt on the balance sheet with no cash generation. And they're doing it at a moment when the used car market is kind of in the dumper. And so that-- the timing of all those issues is the confluence of events that has seen the stock go down 70% over the last six weeks.

BRAD SMITH: Brad, and some of the earnings that we've seen come across e-commerce and those divisions within companies like Walmart, like Target, some of that growth has stalled in terms of sales. And so for other internet names that are relying on so much of those sales to come forward over e-commerce and for something as costly as cars even, but kind of stretching this out even further across some other segments, where are we going to see that next leg of growth come from?

BRAD ERICKSON: Yeah, I think for-- obviously, we cover broader internet, not just used car retailers. I think for verticals that are very interest rate sensitive, like real estate, like cars, I think that's where you're seeing a particularly strong impact right now. For e-commerce, I think we're more in this stage of, we are, to some degree, lapping some of the most difficult comps from COVID.

Remember last year, through the early spring, actually, for the first couple of quarters of the year, stimulus dollars were influencing e-commerce volumes substantially higher than probably would have happened. And so we're in the midst of lapping those comps right now. I actually think e-commerce spending looks a little bit more balanced as we head into the summer and the holiday. But some of these interest rate segments, like I mentioned, are certainly being the hardest hit at this point.

JULIE HYMAN: And so, Brad, just very quickly here, sort of divorced from the fundamentals, are many of these stocks dead money in the interim during this interest rate increase cycle?

BRAD ERICKSON: Unfortunately, I'd probably say yes. And the reason is, obviously, there's a ton of negativity and concern and everything priced into these stocks. The problem is, is that so long as the 10-year is potentially moving, interest rates are rising, there's no-- investors can't get comfort with forward estimates, because we're still going the wrong direction. I think, for instance, we have done some channel work recently around real estate agents and ad spending.

And I think there, you've seen a superfluid environment, just even over the last two months, where spending decisions are actively happening at this point. And obviously, the same goes for used car pricing. So long as we're seeing rates go the wrong direction, investors just won't get comfortable without period estimates. And that's a recipe for stocks not working.