Is Carvana’s Stock Overvalued Compared To CarMax?

by Trefis Team
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E-commerce based used-car retailer, Carvana’s (NYSE: CVNA) P/S (price-to-sales) multiple of 2.7x is higher than the figure of 0.9x for CarMax (NYSE: KMX), a used-car industry leader. So, is Carvana stock too expensive compared to CarMax stock? We believe that Carvana stock is currently overvalued compared to CarMax stock, due to the notable mismatch in their current P/S multiples when compared with returns and risk profiles for the two companies over recent years.

Carvana’s revenue growth is much higher (114% average annual revenue growth over the 2017-2019 period vs about 8.9% for CarMax), which explains the higher P/S multiple. However, CarMax’s returns are better. Specifically, CarMax’s net income margin (net profits as a percent of revenue) stood at over 4% in 2019, while Carvana’s margins came in around -9%. Using another measure of return, CarMax’s -1% free cash flow margin (net profits adjusted for non-cash expenses as a percentage of revenue), is also higher compared to -21% for Carvana.

Our dashboard Carvana vs. CarMax: Is CVNA Stock Appropriately Valued Given Its Higher P/S Multiple Compared to KMX? details the fuller picture based on Revenue Growth, Returns (ability to generate profits from growth), and Risk (sustainability of profits), parts of which are summarized below.

1. Revenue Growth

Carvana’s growth has been higher than CarMax over the last two years, with Carvana’s Revenue expanding at an average rate of 114% per year from around $900 million in 2017 to $3.9 billion in 2019, versus CarMax’s Revenue which grew 8.9% from $17.1 billion to $20.3 billion.

  • More consumers appear to be moving from the new vehicle market into the used vehicle market, creating an enormous market opportunity. Higher job and economic uncertainty, the decline in new vehicle inventory due to the forced shutdown of automakers, low-interest rates, and less inclination of people to travel in public transport led to people opting for more value in the used car market during the pandemic. This positive demand should support higher pricing and a quick rebound for both Carvana and CarMax.
  • In addition, Covid-19 is normalizing the idea of buying cars online. For context, Carvana saw structural shifts in customer preferences leading to the strongest demand it ever saw in recent Q2 results – with revenue growth rebounding to 40% year-over-year (y-o-y) late in Q2 from 30% y-o-y declines seen in early April. Similarly, CarMax also saw a record quarter with sales up 3% in Q2, due to a strengthened used-car sales environment and solid execution in operations. In fact, KMX also completed the roll-out of its omnichannel offering in the Q2.
  • Going forward, as the companies ramp up capacity, they should see sales growth accelerate sharply from ther respective recent paces.

2. Returns (Profits)

Coming to Returns, CarMax has a clear edge over Carvana.

  • Carvana has a leveraged balance sheet and still-negative free cash flow. Carvana’s Free Cash Flows as a percentage of revenue stood at about -21% in 2019, much below CarMax’s -0.8% over the same period. 
  • Carvana’s Return on Invested Capital (ROIC) is steeply lower compared to CarMax (-67% vs. 25%).

3. Risk

Carvana looks like the riskier of the two companies from the perspective of financial leverage. Although both Carvana and CarMax are highly levered companies with their total debt exceeding equity.

  • Carvana’s Debt to Equity ratio was much higher than CarMax’s in 2019. However, Carvana has the cash to assets ratio of about 5.6%, which is slightly higher than CarMax’s 1.6%.
  • Both companies’ cash situation is not reassuring when compared to their debt. For example, at the end of June 2020, Carvana’s cash stood at $246 million, with about $966 million worth of long-term debt. On the other hand, CarMax’s cash stood at $712 million at the end of August 2020, with about $1.9 billion worth of long-term debt.
  • CarMax is relatively better placed to deal with the current crisis, given it sits on a massive auto loans receivables of over $12 billion. It thus becomes important for CarMax to collect the right amount of receivables in the coming months, or resort to other sources, such as equity dilution or debt issuance.

 

The net of it all

In summary, the net advantage moves back to CarMax based on its better returns as compared to Carvana. Though both companies are likely to tide over the current crisis, our analysis suggests that CarMax could perform slightly better than Carvana. Despite higher average revenue growth, Carvana stands riskier among the two companies based on its relative debt burden, as well as the sensitivity of its stock price to revenue growth.

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