Why Investors Should Take Carvana Stock for a Spin

In addition to decorating the tree this holiday season, car owners may want to adorn their rear-view mirrors with fuzzy dice and air fresheners. Why? The used car market is sizzling!

An unlikely beneficiary of the pandemic, the used car market is suddenly one of the hottest areas of the domestic economy. With people opting to avoid planes and public transportation, used car and truck prices jumped 6.7% last month, the biggest increase since 1969.

Surging demand for used vehicles and changing auto shopping patterns are cause for celebration at Carvana (NYSE:CVNA). Safety-conscious consumers are becoming more comfortable with buying big-ticket items from the comfort of their own homes—and this includes used vehicles. People can take their time to research and purchase online instead of being tailed by a commission-hungry used car salesperson.

As Carvana gets ready to report third-quarter results, here's why investors should take the company's stock for a test drive.

What are the Recent Developments at Carvana?

Last month Carvana provided a peak under the hood regarding its third quarter. The company said it expects to post record performance across several key metrics. Retail units sold, total revenue, total gross profit per unit, and EBITDA margin are all expected to reach all-time bests. EBITDA is forecast to approach the breakeven point which is a good sign for the future profitability.

The summer surge at Carvana has been due to two things. First, tight used car supply during the second quarter loosened in the latest quarter. Sellers took note of increasing used car prices and in some cases a need for cash during tough economic times. Meanwhile, buyers have been lining up to purchase used vehicles amid attractive auto loan rates and lower demand for public transportation.

In reaction to the Q3 preview, Carvana shares jumped 30% in over five times the stock's 90-day average trading volume on September 22^nd.

Amid general market turbulence, Carvana's stock has since retreated to its 50-day moving average in relatively light volume. This has set investors up for a great buying opportunity ahead of what should be a blowout Q3 earnings report on October 29^th. It wouldn't be surprising to see Carvana's stock pop at least 20% and return to the levels seen after the late September announcement.

What are Carvana's Long Term Growth Prospects?

Used car prices are likely to remain elevated for some time as people lean towards personal transportation. But looking beyond the near-term pandemic boost, Carvana investors have reason to expect solid long-term growth.

Car buyers' habits appear to be changing for good. According to a recent Piper Sandler report, downloads of the Carvana app have been trending higher by around 15% year-over-year. This is an important metric because app downloads have a strong direct relationship with Carvana's retail car deliveries.

And with a growing inventory of more than 16,000 used vehicles, buyers have a lot to choose from. After seeing detailed 3D pictures of the exterior and interior of a vehicle, car buyers can schedule an at-home delivery or pick the car up from one of Carvana's 24 nine-story vending machines.

Carvana's trademark innovation is the country's first fully automated, coin-operated car vending machine. It represents a novel, car buying experience that consumers are embracing. Aside from contactless delivery, people have taken to Carvana's below dealer prices and 90-day no payment promotion. The 7-day money back guarantee has also made leery customers more willing to try Carvana.

Part of the appeal for customers is Carvana's comprehensive business model which encompasses the entire car ownership spectrum. Auto financing, inspection, and repair services make for a one-stop car buying experience comparable to the traditional car buying process. And since Carvana doesn't employ on-site salespeople or spend on fancy showrooms (and daily coffee and donuts), its model has cost advantages over car dealers.

In addition to its core used car business Carvana generates revenue from wholesale vehicle sales and auto finance receivables sold to third parties which together account for about 13% of revenue.

Can Carvana Capture Market Share?

Carvana has the size and business model that should make it a leader in the online segment of the used car market for years to come. It now has a presence in 261 markets and room for further geographic expansion. Market share is there for the taking in the highly fragmented $840 billion U.S. used car market which is comprised of over 43,000 used car dealerships.

Last year Carvana's retail vehicle sales surged 89% to 177,549 units. This year it is on pace to sell over 215,000 vehicles. Management is targeting annual unit sales of 2 million which would give Carvana a 5% share of the market. While this mark is still miles away, digital trends used car buying suggest Carvana may reach its destination sooner rather than later.

Despite the recent 20% pullback from its peak Carvana's stock is not cheap. The company has an enterprise value of $15.5 billion which is roughly 3.5x its trailing 12 months sales.

However, the premium is warranted given Carvana's accelerating growth and longer-term prospects of consolidating the used car space. Look for Carvana's share price to get a turbo boost from this week's third-quarter report—and its strong market position to drive solid investor returns further down the road.