Here’s Why Carvana (CVNA) Surged in the Second Quarter

Steel City Capital, an investment management company, released its second quarter 2022 investor letter. A copy of the same can be downloaded here. The fund declined 11.2% net of fees in the second quarter, compared to a decline of 16.4% in the S&P 500 Index and 17.5% in the Russell 2000 Index. Market conditions like inflation, rate hikes, and fears of a recession affected the fund’s performance in the first half of the year. For more information on the fund’s top picks in 2022, please check its top five holdings.

Steel City Capital mentioned Carvana Co. (NYSE:CVNA) in the letter and discussed its views about the company. Carvana Co. (NYSE:CVNA) provides a platform for used car buying and selling and is headquartered in Tempe, Arizona. The stock of Carvana Co. (NYSE:CVNA) closed at $51.00 per share on August 15, 2022. One-month return of Carvana Co. (CVNA) rose 123.19% while its shares lost 85.52% of their value over the last 52 weeks. Carvana Co. (NYSE:CVNA) has a market capitalization of $9.058 billion.

Here’s what Steel City Capital specifically said about Carvana Co. (NYSE:CVNA) in its Q2 2022 investor letter:

“Carvana Co. (NYSE:CVNA) shares are up more than 100% from recent lows. The quarter was predictably poor: retail unit growth slowed to ~9% year/year and the company generated negative EBITDA of $230 million. What bulls saw in the report was growth in per-unit gross profit (GPU) and a reduction in per-unit SG&A which they interpreted as an inflection in the business and a sign that the march to profitability has resumed in earnest. I think they’re getting high on their own supply. While there may be some continued improvement in the “metal margin” component of GPU, all-important finance GPU is unlikely to return to 2020/2021 levels in the absence of the ABS securitization market heating up again. At the same time, bulls have latched on to the company’s so-called “stretch-goal” of SG&A reaching $4,000/unit by the fourth quarter of the year. Let me start by pointing out something that is being grossly mischaracterized: this “stretch goal” is being conflated with “guidance.” It is absolutely not guidance. I view “stretch goal” as a sort of squishy term management can use to offer some hope for the future while simultaneously protecting themselves from getting sued if (when) they don’t hit this target.

More importantly, I think there is a near-zero probability that the company comes anywhere close to this level of SG&A/unit. Notwithstanding all of the hype about cost cutting, like-for-like cash SG&A (ex. ADESA and one-time restructuring expenses) dropped from ~$690 million in 1Q’22 to $640 million in 2Q’22, a reduction of ~7.0%. Laudable, but nowhere near the levels required to reach the “stretch goal.” The challenge is that CVNA has pulled in its horns with respect to retail unit volume growth in order to preserve liquidity, but the path to SG&A of $4,000/unit requires a reacceleration of unit growth in order to leverage fixed costs. This is a case of “the trend is not your friend,” with alternative data points indicating unit volumes declined sequentially in each month since March. And with the pending $1.0 billion reduction of the company’s floor plan facility by the end of September, the type of unit increases required to hit the target look increasingly unlikely..(Click here to read more)”

Photo by Parker Gibbs on Unsplash

Carvana Co. (NYSE:CVNA) is not on the list of  30 Most Popular Stocks Among Hedge Funds. As per our database, Carvana Co. (NYSE:CVNA) was held by 48 hedge fund portfolios at the end of the first quarter, which was 56 in the previous quarter.

We discussed Carvana Co. (NYSE:CVNA) in another article and shared the list of stocks to consider buying in June. You can check our hedge fund investor letters Q2 2022 page for more investor letters from hedge funds and other prominent investors.

Disclosure: None. This article is originally published at Insider Monkey.