Carvana pressured to cut costs amid waning used-car demand

Carvana Co. may be back on a growth trajectory, but what investors really want to see is how well it's controlling its costs.

With consumer confidence falling and the Federal Reserve raising interest rates to fight the surge in inflation, Carvana and other online used-vehicle retailers may see little growth in demand in the coming quarters.

That's putting greater pressure on cost savings, with one analyst calling the second quarter "pivotal" for Carvana, which is set to report results Aug. 4. Recession risk has smaller rivals under the microscope, too, after Shift Technologies Inc. cut 10 percent of its staff and Vroom Inc. changed CEOs.

"Cash management and navigating through the back half of the year are going to be really important because it's hard to say, with any kind of certainty, when demand starts to get better," said Daniel Imbro, a Stephens Inc. managing director covering the retail and hardlines sector, which includes Carvana.

Higher prices and rising interest rates are pushing up monthly used-vehicle payments, which could price more buyers out of the market, said Chris Pierce, a Needham and Co. senior analyst who covers Internet services, including Carvana.

That's certainly not specific to Carvana, but it's not helping the company, either, he added.

"It's a high fixed-cost business," Pierce said. "You need to sell units to offset those fixed costs, and when they sell less units, that's not good."

If high used-vehicle prices stick around and the auto loan environment becomes more difficult — particularly for consumers with lower credit scores — that could present a "big problem" for Carvana, said Douglas Arthur, a Huber Research Partners managing director and research analyst who covers the retailer.

"The Carvana model is built for super-high demand," Arthur said.

Carvana declined to grant an interview with CEO Ernie Garcia ahead of the release of second-quarter results.

The quarter ending June 30 was a crucial time for Carvana to work on the factors it can control, such as managing its cash spend, analysts said: If it efficiently cut expenses, it will be better able to handle a potential lull in demand. Carvana did cut 2,500 operations jobs mid-quarter in an attempt to reduce expenses. But it also took on more debt to fund its acquisition of the ADESA U.S. wholesale auction business from KAR Global.

"The fact that they allowed it to get to this situation is not encouraging, and, unfortunately, it is a pivotal quarter around expense control," Pierce said.

At the moment, expense control is requisite for the company and its shot at future profitability, Pierce said, because "there's not going to be a ton of upside around units and unit growth."

And because Carvana's earnings model also depends on per-vehicle profit, the company will likely continue to target pulling in more money for each vehicle it sells, Arthur said.

Carvana reported total gross profit per vehicle of $3,656 in the first quarter of 2021. That fell to $2,833 in the first quarter of 2022 after the company sold fewer cars than expected, punching up costs per vehicle.

Vroom and Shift this year said they, too, aim to reduce costs. In May, Vroom indicated it would cut marketing expenses as part of its attempt to realign for profitable growth. It also didn't rule out a work force reduction.

Shift said its cash use in future quarters would likely be lower than it was in the first quarter, when it had several one-time costs. It has also listed a going-concern warning in federal filings. Sharon Zackfia, who covers all three online used-vehicle sellers as an analyst at investment bank William Blair, previously told Automotive News that Shift likely has resources to get through 2023, when the market may normalize.

Though demand risks loom, Carvana could retail more vehicles in the second quarter than it did in the first quarter or in the year-earlier period, according to a number of analysts' estimates.

The company retailed 105,185 vehicles in the first quarter. It could report selling roughly 115,000 vehicles at retail in the second quarter, Imbro said.

By comparison, Carvana sold nearly 108,000 vehicles and reported its first and so far only net profit in the second quarter of 2021.

Pierce told Automotive News that second-quarter retail vehicle sales estimates have diminished in the last month and a half.

"The number of units people thought they would sell this quarter has come down as their weekly numbers have come down" in third-party reports, Pierce said.

Analysts who closely follow Carvana have been reducing their second-quarter retail sales estimates, which previously topped 120,000, according to Huber Research's Arthur.

Carvana ranks No. 2, behind only CarMax, on Automotive News' list of the top 100 retailers ranked by used-vehicle sales, with retail sales of 425,237 used vehicles in 2021.