CAS Investment Partners April 2022 Letter To Investors
CAS Investment Partners April 2022 Letter To Investors
CAS Investment Partners April 2022 Letter To Investors
4/29/2022
Clifford Sosin
CAS Investment Partners, LLC
Westport, CT 06880
Performance Summary
Sosin Partners, LP* SPY**
2012*** 14.0% ‐1.5%
2013 66.6% 32.3%
2014 6.3% 13.5%
2015 14.5% 1.3%
2016 22.0% 12.0%
2017 31.2% 21.7%
2018 29.8% ‐4.6%
2019 64.5% 31.2%
2020 96.5% 18.3%
2021 3.9% 28.7%
Q1 2022 ‐26.7% ‐4.6%
YTD 2021 ‐26.7% ‐4.6%
See disclaimer regarding comparison to indicies at the end of this letter.
* Performance net of 2% management fee and 20% performance allocation.
** Includes dividends reinvested.
*** Sosin Partners LP launched 10/9/2012; performance for both the fund and SPY shown from that date.
To My Partners:
As shown in the performance summary, during the three months ended March 31, 2022, Sosin
Partners, LP reported a loss on a mark to market basis net of all fees, expenses, and performance
allocations of 26.7%. The broad market as represented by the SPY ETF including dividends was
down 4.6% during the same period.
Since its inception on October 9, 2012, Sosin Partners, LP has reported gains on a mark to
market basis net of all fees, expenses, and performance allocations of 1,082.3%; this represents a
29.8% compound annualized rate of return. The SPY ETF is up 271.1% including dividends
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during that period representing an 14.8% compound annualized rate of return.
The Balance Sheet
We ended the quarter with eight stock positions on the long side of the balance sheet, totaling
99.6% of equity capital. As of March 31, 2022, our largest holding, representing 25% of equity
capital, was Carvana. Our second largest holding represented 24% of capital, and the
remaining positions ranged from 4% to 17% of equity capital. No other positions are material
individually or collectively. Changes between December 31 and March 31 in our relative
holding sizes resulted predominantly from changes in market prices.
Since the end of March, we have continued to experience meaningful mark to market losses. As
of this writing the portfolio is down approximately 43% year to date as compared to the market
which is down only 10%.
Mark to Market Performance
In his 2016 essay The Agony of High Returns, Morgan Housel lays out the experience of owning
the best performing stocks of the prior decades. His point, articulated elegantly and
demonstrated compellingly, is that the owners of the best performing stocks invariably must
endure many, often substantial drawdowns. The simple fact is stocks do not rise in straight
lines.
We are in the midst of one of the more substantial drawdowns since the inception of the
partnership. That these sorts of drawdowns are to be expected and are a normal part of
investing over the long term does not make them fun.
While a number of our holdings are generally progressing well and the stocks appear to be
down for no obvious identifiable business reasons, our largest holding, Carvana, is in the midst
of a confluence of challenges that obscure what I believe to be its very bright future.
It is my observation from business history that few great businesses are built without mistakes,
setbacks and challenges. In retrospect, these challenges appear obviously soluble taking the
form of mere blips on the path of a company’s inexorable rise. In the moment, however, they
can appear insurmountable and terrifying.
Carvana’s challenges, especially when coupled with the precipitous decline in its stock price,
clearly seem terrifying, however as I will explain in this letter, I believe that in due time we will
look back at them as bumps in road on the company’s path to success.
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I am not immune to mistakes, and I promise that when I eventually make a doozy I will put it
here at the top of this letter. In this case, however, I do not believe I have.
This brings me to a question that I suspect is on many of your minds…
So What’s Going on with Carvana?
In my prior letters, I’ve laid out our overall thesis for Carvana. Namely, why I think Carvana’s
consumer offering is radically superior to that of traditional dealerships, why the offering is
extremely difficult to replicate, Carvana’s compelling unit economics, and finally, the
company’s vast market opportunity/ profit potential. In my last letter, I also described how the
Omicron wave of the COVID‐19 pandemic was impacting the company’s logistics system and
thus its ability to serve its customers.
At the time I wrote my last letter, I had anticipated that as the Omicron wave subsided, the
company would see a fairly rapid return to its original growth and profit trajectory. Alas, this
clean and quick return to normal was not to happen.
Since my last letter, the company has been impacted by two separate issues which continue to
weigh on its performance:
First, the set of logistics challenges initially brought on by the Omicron wave and subsequently
exacerbated by a number of other factors have proven more enduring than I had originally
expected. Second, the used car retailing industry in aggregate has seen a significant slowdown
in the volume of vehicles transacted. Taken together, these trends have impacted Carvana’s
growth.
As you can see in the graph below, while Carvana’s weekly unit volume increased from the
Omicron induced lows of January and February, the increase was small relative to the prior
year, resulting in a significant slowdown in the company’s year over year growth rate.
As the graph shows, over the past couple of months, Carvana’s growth has been running at
about 15% year over year. While a disappointing pace for Carvana, it should be noted that this
is significantly better than the overall used market which is declining by approximately 15% year
over year. A fact made more significant by the impact of Carvana’s internal logistics issues on it
is growth.
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Carvana Weekly Sales (Source: YipitData)
Given the scope of its operations and its high pace of growth, Carvana hires roughly six to
twelve months ahead of need. Consequently, this disappointing level of sales (as well as the
impact of a spike in interest rates and Omicron related costs) left the company with far greater
costs in Q1 than its revenue could support, resulting in a $364 million EBITDA loss in the
quarter as compared to the near breakeven levels achieved in the prior year’s Q1 and full year
2021. Additionally, since the logistics issues are expected to extend through Q2, the company
also faces another meaningful EBITDA loss in Q2.
Further complicating matters, after years of consideration and negotiations, the company
announced its acquisition of Adessa’s physical auction business for $2.2 billion in February, just
prior to these issues coming to the fore. The Adessa purchase was made primarily to gain
ownership of their locations (very large, well located, appropriately zoned parking lots) as
logistics sites and sites to build new inspection and reconditioning centers (IRCs). The auction
business itself was not the reason for the acquisition. The company had initially planned to
finance the acquisition and $1 billion cost of building these IRCs with $3.2 billion of secured and
unsecured debt.
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Given these unanticipated losses and the financing needs for the acquisition and related build
out, the company issued $1.25 billion of stock at $80 per share and placed $3.25 billion of senior
unsecured notes at the fairly high rate of 10.25%. We participated in the offering buying more
than our pro rata share and thus somewhat increasing our position and our percentage
ownership of the company.
Before we discuss how these events might impact our investment (spoiler alert: while I
anticipate short to medium term impacts I don’t believe it should matter too much in the long
term), it is first worth reflecting on whether Carvana’s logistics issues and the weak used
vehicle market do indeed explain Carvana’s weak sales. Could something else, something that
would be disconfirming to my thesis, be causing the slowdown? I don’t believe so.
First, Carvana’s ongoing logistical issues are evident on the website for all to see. While I’ve
been informally tracking inventory availability throughout our investment, in light of these
issues, we set up more systematic tracking starting in early March.
As you can see in the graph below, in the forty markets we sampled, Carvana is only showing a
fraction of its nearly ninety‐thousand units of inventory to most consumers. Moreover, this
limited selection of vehicles is available in six to seven days on average. When Carvana’s
system is operating normally, all inventory should be available to all consumers within seven
days and often as soon as the next day, yielding average lead times in the four day
neighborhood or less.
Carvana Weekly Available Inventory & Delivery Lead Times (Source: CAS Analysis)
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That selection and lead times is an extremely important driver of conversions is something that
I have been aware of for years through conversations with both management and former
employees. Indeed, the improved customer conversion rate that arises by offering a greater
selection and shorter delivery lead times is one of Carvana’s key economies of scale versus
would be copycats. Thus it is unsurprising that limited selection and extended lead times
would reduce sales.
Second, the overall decline in used car transactions has been broadly recognized in the industry.
Below, I’ve included a chart from Cox Automotive that shows the significant industry decline.
I’ve also included weekly sales for CarMax, which also show a roughly 15% decline versus last
year. Simply put, the overall decline in the used vehicle industry is pronounced and well
documented. Indeed, this decline is similar in magnitude to the decrease during the Great
Recession, when CarMax’s same store sales declined by 16%.
CarMax Weekly Sales (Source: YipitData)
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Used Vehicle Industry Trends (Source: Cox Automotive)
Carvana also cited 50% Q1 year over year growth in its sales to customers with greater than 700
FICO scores as compared to 14% overall. As I’ll discuss more below, it is widely believed that
high car prices and to a lesser extent higher interest rates have are causing the overall decline in
industry volume. As customers with a greater than 700 FICO are less impacted by industry
affordability issues but are impacted by Carvana’s logistics issues, we would expect to see a
smaller slowdown in the pace of sales to higher FICO customers than to lower FICO customers.
So this fact is consistent with that explanation.
Clearly there is direct evidence pointing to and supporting our explanation for Carvana’s weak
volume.
However, we should not just look for evidence related to our proposed explanations of
Carvana’s slowdown. We must also consider alternative hypotheses and see if they are
consistent with the facts. Let’s consider three: 1) that Carvana could be reaching saturation for
its offering; 2) that Carvana’s strong demand up until now was a result of the COVID‐19
pandemic and that with the abatement of the pandemic their market opportunity is much
smaller; and 3) that the used auto retailing competitive landscape has changed.
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The table below shows Carvana’s penetration by market and market growth rates in its top 25
markets by unit volume in Q4 (the most recent data available):
Carvana Market Penetration and Growth (Source: YipitData, CAS Analysis)
Share Growth Units
Phoenix AZ 4.1% 33% 5,077
Columbus OH 3.9% 29% 2,123
Atlanta GA 3.4% 53% 5,340
Austin TX 2.9% 73% 1,568
Nashville TN 2.7% 43% 1,338
Charlotte NC 2.6% 71% 1,699
Virginia Beach VA 2.5% 70% 1,187
Las Vegas NV 2.3% 149% 1,340
Orlando FL 2.3% 123% 1,507
Raleigh / Durham NC 2.1% 30% 1,061
San Antonio TX 2.0% 73% 1,303
Dallas TX 2.0% 97% 3,872
Pittsburgh PA 1.9% 38% 1,228
Newark NJ 1.7% 64% 3,118
Philadelphia PA 1.6% 48% 2,723
Tampa FL 1.6% 69% 1,295
Washington DC 1.5% 97% 2,548
St. Louis MO 1.4% 113% 1,064
Detroit MI 1.3% 20% 1,583
Chicago IL 1.2% 43% 3,019
Houston TX 1.1% 31% 1,966
Miami FL 1.0% 77% 1,603
Boston MA 1.0% 27% 1,262
Los Angeles / Riverside CA 0.8% 47% 4,020
New York City NY 0.5% ‐15% 1,246
Were Carvana reaching saturation, you would expect slower growth in more mature markets.
As you can see, in Q4, Carvana achieved very high levels of growth in its largest and most
penetrated markets.
Carvana’s overall penetration in Q4 2021 was a bit over 1%. If Carvana’s growth slowdown
were due to the offering reaching saturation, it is difficult to explain why growth in its most
penetrated markets did not slow earlier or why growth in its least penetrated markets would
slow now.
Recall also the fact that Carvana saw significantly higher growth in its sales to customers with a
greater than 700 FICO. Were market saturation to blame for Carvana’s weak volumes it is
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tough to see why this would so disproportionately impact consumers with higher FICOs versus
those with lower FICOS.
Returning to the market share and growth rate table, notice that Carvana experienced some of
its highest penetration and fastest growth rates in markets such as Phoenix, Columbus and
Atlanta. These are not markets that had particularly stringent social distancing norms during
the pandemic. Conversely, Carvana has relatively under‐performed in markets such as Boston,
New York and San Francisco, where COVID‐19 impacted behavior more significantly. If
Carvana’s issues were due to the end of COVID, this fact pattern is hard to explain.
Further, comparing Carvana’s weekly unit volumes with COVID‐19 cases (shown below)
would seem to show that COVID waves reduced Carvana’s sales (due to the impact on
Carvana’s operations) instead of increasing them. Again, this is not consistent with the lapsing
of a COVID bump.
Moreover, recall the divergent performance between above and below 700 FICO customers.
Did COVID only impact low FICO consumers? How could one explain the seeming
indifference to changes in COVID‐19 by Carvana shoppers with better FICOs versus those with
worse FICOs?
The argument that the competitive landscape has meaningfully changed is similarly
unreasonable. The used car retailing industry is highly fragmented, and one needs only to
spend a few minutes perusing a typical dealership’s website to realize that they still offer
essentially the same experience they did in 2019, let alone in late 2021.
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But if competitors had evolved to improve their offering, why did they seem to so
disproportionately affect Carvana’s less than 700 FICO consumers? For that matter, if the
changing competitive landscape were the explanation, how can it be that CarMax, which is
arguably the industry’s technology/ customer experience leader outside of Carvana, still
transacts only 11% of its sales online? Or more importantly, why is CarMax facing such large
year over year declines in unit volumes if Carvana’s sales losses are their gains? Taking a
broader view of the market, while there are other online initiatives by competitors and they are
worthy of monitoring as long term potential competitive threats, they are simply far too small
to explain Carvana’s recent performance.
The simple reality is that it seems none of these (and other) alternative hypotheses make sense
in light of all the facts, while the company’s explanation, a mix of overall market declines and
internal logistics issues does.
Having (presumably) correctly diagnosed the reason for Carvana’s lower unit volume we now
need to contemplate the impact on our investment.
Carvana’s management team believes they will have their logistics issues resolved by roughly
the end of Q2. As an outsider, I haven’t found a way to verify this assertion. However, we
know that 1) the team is very talented and aligned, 2) they have had this system running
properly in the past, and 3) hub and spoke logistics systems like theirs are routinely operated by
other companies (think Amazon, FedEx, etc.). So I don’t see any reason to be particularly
concerned that the system won’t be restored to normal operations in a timeline consistent with
their expectations. Resolving the logistics issues should meaningfully improve Carvana’s units
and profitability.
The timing of the resolution of the broader used car industry decline is far more uncertain and
so are its impacts.
Most used car buyers transact in order to swap into a newer and nicer vehicle. Thus, for most
used car buyers, the ~40% increase in the price of used vehicles and to a lesser extent the rise in
interest rates has made trading up to a new vehicle less attractive or affordable.
For this reason, most industry observers, including me, believe that the primary cause of the
weak used vehicle market is poor affordability, although undoubtedly other factors such as
consumer confidence, gas prices, inflation, etc., must all also play a role.
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Assuming affordability is a major culprit, then in order for the used car industry to return to a
normal level of activity, used vehicle prices have to normalize. This normalization in turn
requires an increase in the rate of new vehicle production, which has been disrupted by supply
chain issues in the semiconductor industry.
My guess is as good as yours as to when new vehicle production will recover. Most industry
observers expect some improvement in the back half of 2022 with bigger gains in 2023, but these
prognostications are uncertain. It is possible, even likely, that the auto market deteriorates
further before normalizing.
While industry volumes are weak, Carvana’s volumes will be impacted. If the industry
worsens, Carvana’s volumes will worsen. However, when the industry normalizes Carvana’s
volumes should similarly accelerate. Through this uncertainty, the management team will need
to adjust its largely fixed and highly scalable cost structure to match demand in order to
marshal its liquidity resources as it continues to win share and awaits an eventual industry
recovery. Fortunately, the company is in a strong position to achieve this.
During 2021 the company incurred a $5 million EBITDA loss on 425,237 units sold despite
incurring substantial investments for growth. The company’s recent weekly performance
suggests that it is running at around 500k units on an annualized basis despite its ongoing
logistics challenges.
I estimate that Carvana makes $2,700 of incremental profit on each unit it sells. This unit
profitability across 500k units means that, excluding the cash flow from the Adessa physical
auction business, the company has roughly $1.3 billion per year of contribution margin with
which to cover its fixed costs, interest expense and growth investments. This $1.3 billion of
contribution margin will increase as the company’s unit volume increases with normalization of
its logistics system and ongoing share gains. The company also should also generate $100
million of profitability annually from Adessa’s physical auction business.
While the company’s $600 million of annual interest expense is largely fixed, and a certain level
of fixed/ overhead costs are necessary to run the company, the company’s growth investments
are under the management’s control.
Simply put, Carvana has a great deal of latent margin potential. This potential should allow the
company to pursue its growth ambitions, albeit at a slower pace of expansion, without
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meaningfully accessing the capital markets or counting on a significant used vehicle industry
recovery.
In addition to its latent margin potential, Carvana also has ample resources for any planned or
unplanned cash shortfalls. With its recent capital raise, the company has $2.663 billion of cash
and another $1.916 billion of unpledged assets (mostly real estate) available to manage through
to profitability.
Clearly, the assertion here that Carvana has ~$2,700 of incremental profit per unit is a critical
assumption in assessing the latent profitability upon which this analysis relies. Because this
topic is fairly involved and detailed, I’ve added an appendix on the topic at the end of this letter
to which I would refer you.
Fortunately, a weak used vehicle retailing environment is not all bad news for Carvana.
Carvana competes in a highly fragmented market with tens of thousands of independent
dealerships and around seventeen thousand franchise dealerships. Franchise dealerships are
making record profits in this environment, on account of record new car margins and profits
from off lease vehicle trade‐ins. Independent dealerships, on the other hand are struggling due
to a combination of low volume and thinner wholesale‐retail margins.
Given their struggles, should the overall industry demand weakness persist (or worsen), many
independent dealerships will fail. Collectively, independent dealerships account for ~60% of all
used vehicle sales through dealerships and around ~40% of transactions in less than ten year old
vehicles (where Carvana competes). Thus as independent dealerships fail, Carvana stands to
win share (recall Carvana has only a bit over 1% market share). This observation implies that
Carvana’s pace of share gains should increase the longer this environment lasts. It also
provides meaningful protection to Carvana in the event the used car demand environment
worsens, as such worsening will accelerate the independents’ exit from the market.
Carvana also competes on a limited basis with other companies who are attempting to copy its
model, most notably Vroom. Vroom was in a very weak position going into this recent demand
decline, and according to web scraping data has seen a very significant decline in its unit
volumes recently. Should the demand environment remain weak or weaken further, it is
difficult to see how Vroom survives. While Vroom’s small size means that its demise would
have no meaningful impact on Carvana today, the elimination of this potential long term
competitor would be a positive.
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Another positive byproduct of the weak demand environment could be to boost Carvana’s
marketplace program. By way of background Carvana allows certain dealerships to market
their vehicles on the Carvana site in exchange for sharing in the economics and subject to a
number of restrictions to ensure a great consumer experience. Carvana has been offering this
marketplace model to dealerships over the past year and a half. To date, dealer feedback has
been excellent but dealer uptake has been modest. Dealers simply didn’t need help selling cars
given their limited inventories and strong demand. The decline in demand and likely struggles
at independent dealerships should increase dealer interest in the marketplace program.
Carvana also has opportunities to “self‐help.” For example, the company can allow co‐signers
on loans, increase its focus on older vehicles and/ or begin offering vehicles that have been in a
flood or an accident (with appropriate descriptors for consumers). Each of these initiatives, and
others, has been in the works for some time but has not been rolled out at scale due to the
resource demands required of an over‐stretched system.
Cost and process efficiency is another area where Carvana can focus managerial attention that
was previously focused on managing rapid growth. Assuming they are realized, these
improvements to the model should improve profitability in the near‐term while also providing
benefits to Carvana for years to come.
Eventually, of course, today’s industry headwinds will become industry tailwinds as overall
industry activity recovers to normal levels. The used car industry has existed for many decades
and tended to have fairly consistent levels of activity over time. There is no reason to believe
that in the long‐term this will change.
Taken together, as you’ve probably figured out, the ultimate tally of costs and benefits from the
internal and external issues facing Carvana is difficult to calculate. Certainly the approximately
9% dilution and higher coupon on the $3.25 billion of bond financing are both tangible costs.
This year is shaping up to be something of a lost year in terms of growth, and the company’s
growth in the future will probably need to be at a more moderate pace that can be better
managed and funded from internal cash generation. This all means a slower albeit longer and
more cash generative growth ramp.
Conversely Carvana’s competitive position and efficiency will likely benefit from this episode
and the slack and learnings afforded by this experience will make the company stronger.
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Most importantly, in my opinion, there likely isn’t any change to Carvana’s ultimate place as
America’s largest and most profitable car retailer. Provided that belief proves accurate, I don’t
think the long term outcome for owners should be particularly impacted by this episode.
Indeed, from our perspective, given our increased ownership, our long term outcome might be
better, but only time will tell.
Administrative
The Partnership’s Amended and Restated Confidential Offering Memorandum (the “Offering
Memorandum”) requires that I disclose whether my investment in Sosin Partners, LP and
parallel funds represents over 50% of my liquid net worth. I am pleased to say it does. In fact,
it represents over 90% of my entire net worth. My family and I are invested right alongside
you.
In addition, the Offering Memorandum requires that I disclose whether I have any other
significant income generating activities. I do not. The management of the Partnership, the
parallel funds and a single purpose vehicle establish for a co‐investment opportunity in a single
issuer is my sole occupation and source of income.
Conclusion
I am excited for the prospects of our Partnership. While I expect our short term results will be
volatile, I believe that profits over time will be worth the volatility.
You’ll recall that we endeavor to benefit from a virtuous cycle wherein:
1) our investors trust us and allow us the space necessary to focus on long term investment
performance,
2) this long term focus allows us to make better investment decisions unclouded by short
term considerations,
3) better long term investment decisions, in turn, (hopefully) allow us to produce better
long term returns, thus earning our investors’ trust and restarting the cycle.
Other than raising capital to replace any redemptions and approximately $30 million of capital
additions per year, we will not be raising any incremental capital. Given this constraint and the
number of people who have requested access, at present we cannot guarantee access before
2023.
That said, over time we do anticipate continuing to bring on additional partners to backfill any
redemptions and are open to building those relationships well in advance of any potential
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subscription. Potential partners who understand and support our long term approach to
investing should review the Amended and Restated Confidential Offering Memorandum for
more information.
I appreciate your continued trust in me. As always, feel free to call or drop by the office if you’d
like to chat.
Sincerely,
Clifford Sosin
CAS Investment Partners, LLC
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APPENDIX – Detailed Discussion of Carvana’s Unit Economics and Latent Profit Potential.
Like any business, Carvana has direct costs to serve its customers which tend to vary linearly
with the size of the enterprise and overhead costs which tend to scale as the enterprise expands.
Using this framework, I like to think about Carvana’s profit potential as what it makes selling a
vehicle (its contribution margin) multiplied by the number of vehicles it sells, less its fixed/
semifixed overhead. At smaller scale, Carvana’s fixed costs will dwarf its contribution margins.
As the business grows and these costs scale, the overall margins should ultimately converge
towards the contribution margin.
Carvana’s contribution margin consists of its gross profit per unit, less its customer acquisition
costs and the cost of fulfillment. I will assess each competent and its subcomponents below.
Gross profit per unit in 2021 was $4,537 and consisted of $1,638 of used vehicle gross profit (the
margin earned on the spread between buying and selling the vehicle itself), $466 of wholesale
gross profit (the margin earned selling vehicles acquired from customers through wholesale
channels) and $2,453 of other gross profit which consists of gains made originating and selling
vehicle loans and to a lesser extent originating vehicle service contracts, gap insurance and
other ancillary products.
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that the 2021 level understates the company’s normalized potential. At a minimum the $1,638
per unit should be sustainable.
The increase in wholesale vehicle gross profit consisted of an increase in the number of
wholesale vehicles sourced from the public per retail unit sold as well as an increase on the gain
realized on each wholesale vehicle sold. These changes are laid out in the table below.
2020 2021 Increase
Wholesale units sold 55,204 170,556 115,352
Retail units sold 244,111 425,237 181,126
Wholesale units per retail unit 0.23 0.40 0.17
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Second, as Carvana’s loan program has matured, the auto finance market has become
increasingly familiar with the quality of its originations and increasingly willing to underwrite
to the loan’s profitability. This progress continues and represents a long term tailwind to
Carvana’s gain on sale margin..
Based on my conversations, neither participants in the auto finance space nor the company
believe that the 109.7 price achieved in 2021 fully reflects the quality of the originated loans
given the vintage’s relative performance. Put another way, many loan buyers are willing to bid
more (relative to the overall market) than they have previously.
Complicating this picture, however, is the fact that Carvana prices loans weeks if not months
ahead of selling them. If interest rates, loss expectations or risk premiums in the securitization
market move between when Carvana originates a loan and when it sells a loan, Carvana’s gain
is impacted. This dynamic is what played out in Q1 as a combination of sharply rising risk free
rates and widening risk premiums led to Carvana realizing a relatively crummy Q1 gain on sale
of 5.5%. Absent these rate and spread changes, the company estimates its gain on sale margin
would have been 8.8%
During 2021, a much more gradual reverse effect of declining loss expectations and tightening
credit spreads created a subtle tailwind to the gain on sale percentage and to some extent
inflated the 9.7% result.
Based on these datapoints, while Carvana’s loan gain on sales will be impacted by step function
changes in interest rates or funding costs, my sense is that Carvana should continue to earn a
roughly 9% gain on sale margin over time, roughly in line with its 2021 result and that this
premium might even slightly improve as the program continues to mature.
Having assessed each of the subcomponents of gross profit we can now formulate an estimate
of an achievable, sustainable level.
Starting with the $4,537 of gross profit and deducting the ~$150 of excess gross profits in the
company’s wholesale business and the ~$150 of excess gross profits in the company’s financing
business, I estimate Carvana’s sustainable gross profit per unit at approximately $4,200 per unit.
This, is not, however the upper bound of Carvana’s GPU. Carvana should be able to continue
to increase GPU over time as the business matures. Retail margins, which were burdened by
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excess costs as the company builds capacity ahead of need should expand as growth slows and
supply more closely matches demand. Wholesale margins should increase as the company
commences insourcing its auctions and growing its sell‐to‐Carvana business. Other gross
margin should increase as the company increases its sales of ancillary products such as auto
insurance. These opportunities collectively could add to many hundreds of dollars of GPU,
more than offsetting the ~$300 of headwinds I’ve identified above. But these gains will take
time to be fully realized.
In addition to the above opportunities, Carvana likely could also increase its prices to
consumers or institute additional fees. Most dealerships charge some sort of dealer or doc fee.
Depending on state CarMax charges between $100 and $400 per vehicle. Vroom and Shift both
implemented substantial fees in the 2018 and 2019 period and noticed little impact on volume.
Any such fee would clearly add to GPU but potentially at the risk of harming the long term
consumer value proposition.
Assuming the $4,200 per units of gross margin is the right sustainable level for the company in
the near term, we can now turn our attention to customer acquisition costs and fulfillment costs
which are included in selling general and administrative costs.
Carvana spent $479 million on advertising in 2021 to sell 425,237 units. This implies a customer
acquisition cost of $1,126. Carvana’s advertising spending consists of a mixture of brand
advertising spending and performance advertising. Much of the brand advertising has
relatively little impact on near term sales but is intended to help build consumer’s
understanding the Carvana brand over time.
Prior to 2020, Carvana shared its marketing spending and customer acquisition costs by market.
As you can see in the table below, Carvana’s customer acquisition costs generally fall as markets
mature and Carvana was able to achieve customer acquisition costs in the ~$500 per unit range
in its earliest market. Carvana should be able to continue to grow robustly even at lower levels
of marketing spending. During period of 2016 – 2019 while marketing spending was around
$500 per unit, Carvana’s market share in Atlanta expanded from roughly 0.75% to north of
2.0%.
Clifford Sosin 20
Once a vehicle is sold, it needs to be transported to the hub nearest the customer and delivered
to the customer. There are also costs of call center support, title and registration, warranty and
other miscellany. Collectively, I’ve been referring to these costs as fulfilment costs.
Based on web scraping data and vehicle registration data, it is possible to work out that the
average distance a vehicle travels to get to a consumer is approximately 500 miles. At $2.00 of
cost per truck mile and assuming about 7/9ths occupancy of the trucks the cost per occupied
mile should be approximately 30c. This yields trucking costs of approximately $150 per unit.
(The cost of backhaul is included in cost of goods for inbound freight.)
Local customer advocates can pick up or drop off approximately three vehicles per day.
Assuming advocates cost $230 per working day ($60k per year) and assuming they need to
drive 100 miles round trip per event at a cost of $1.00 per mile for the single car hauler the
delivery costs should work out to be around $175 per event. (Note that the pickup and
transportation of cars purchased from the public is allocated into cost of goods sold along with
all inbound freight.)
Based on conversations with former employees, I believe that each unit sold requires
approximately ten hours of labor from inside customer advocates (call center employees).
Assuming a fully loaded cost of $30 per hour for these employees this adds $300 per unit sold.
Carvana also incurs warranty costs on vehicles its sells of approximately $150 and other costs
such as title and registration, customer service accommodations (Ubers, rental cars, etc.) which
probably amount to a few hundred dollars per vehicle.
Taken together these items add up to approximately $1,000 per unit of fulfilment cost.
Clifford Sosin 21
The table below puts the pieces together, showing how I arrive at an approximately $2,700
contribution profit per retail unit. I should be clear that this is an estimate and based on a lot of
assumptions. The point is not to be super precise, per se, merely to observe that the company
has a lot of contribution margins to work with.
Normalized Gross Profit Per Unit $ 4,200
Estimated Customer Acquisition cost ex brand building $ (500)
Fulfilment Costs $ (1,000)
Estimated Contribution Margin $ 2,700
In 2021, the company’s SG&A was $4,781 per unit. Excluding advertising costs, SG&A was
$3,654 per unit. This raises the question of how we can reconcile my estimate that Carvana’s
variable fulfilment costs should be approximately $1,000 per unit with Carvana’s much higher
level of SG&A per unit of $3,654 per unit. The answer, according to the company, is that the
difference is a mix of corporate costs, which should scale, and growth related costs, namely
hiring ahead of need but also recruiting, training, mistakes by inexperienced people and so
forth.
This answer while believable is somewhat unsatisfying since we cannot easily validate them
from the outside…. Except we can.
In late March, 2020, in response significant decline in demand at the onset of the COVID‐19
pandemic, the company froze the hiring of new corporate employees (but made no layoffs).
The company also changed all of its hourly employees to part time and put them on reduced
hours tied to customer demand. These steps effectively froze the company’s central costs while
making its customer facing costs entirely variable and staffed to demand (as opposed to ahead
of demand). The company maintained this posture through the end of Q2, 2020.
As shared by Carvana in its Q2 2020 shareholder letter, the table below shows the company’s
units, and SG&A ex Advertising and D&A by month through Q2 2020.
Clifford Sosin 22
Increase April to May in SG&A ex Adverting & D&A (in millions) $ 4.61
Increase April to May in units 7,375
Incremental SG&A ex Advertising & D&A per unit $ 625.1
As you can see, the company sold 13,548 units in April 2020 and incurred $50.9 million of SG&A
ex advertising and D&A or $3,760 per unit. In May 2020 demand significantly increased rising
by 7,375 units to 20,923 units. However, despite this 54% increase in units, SG&A ex advertising
and D&A increased by 9% equating to $4.6 million or $625 dollars per unit. This small increase
in costs for such a large sequential increase in units is consistent with the view that the variable
fulfillment margins of the business are modest when the business is more optimized for
efficiency.
Note also the overall level of SG&A ex advertising and D&A. In May and June 2020, operating
at an annualized scale of approximately 250k units, the company was able to sustain SG&A ex
advertising and D&A of approximately $2,600 per unit. This compares very favorably with the
company’s actual result of SG&A ex advertising (D&A isn’t so big) of $3,654 in 2021 despite the
business operating at nearly twice the scale in 2021.
Moreover, this level of SG&A per unit ex advertising achieved in early 2020 was not the result
of an austerity plan. The company was investing heavily in growing its corporate capabilities
through Q1 2020 and elected to freeze this growth but not to cut these costs in an effort to
continue making progress on the company’s long term initiatives. If needed, the $2,600 of
SG&A per unit ex advertising could have been much lower.
I believe that this Q2 2020 episode provides robust support for my view that the company’s core
unit economics are robust and that it can be effectively managed to profitability if needed.
Another way to look at the company’s profit potential is to consider each of the elements of its
overall profitability independently based on what the company has actually achieved for each
line item if not at the same or for the business as a whole.
Clifford Sosin 23
For this analysis, I assume:
GPU of $4,200, my estimate of sustainable GPU based on the company’s 2021 actual
result.
$500 of advertising cost per unit, based on the actual experience in Atlanta.
$2,700 of SG&A ex advertising, based on the actual experience of the company during
Q2 2020 with the addition of $100 to estimate the portion depreciation and amortization
expense which runs through SG&A.
This arithmetic is shown below. As you can see, it shows that the company has demonstrated
an ability to earn $1,000 of EBIT per unit at much lower scale and with less mature processes
than it has currently.
Estimated Normalized GPU $ 4,200.0
Atlanta Advertising Expense per Unit $ (500.0)
May, June 2020 SG&A Ex Advertising & D&A per Unit $ (2,600.0)
Estimated D&A not in COGs $ (100.0)
Estimate of demonstrated latent profit potential per unit $ 1,000.0
At the current depressed run rate of 500k units per year, this already demonstrated $1,000 per
unit of EBIT, when combined with the $100 million per year of profits from the Adessa auction
business would be more than enough to cover the $600 million of interest while the company
continues to grow.
Clifford Sosin 24
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Clifford Sosin 25