Zacks Equity Research has issued a "BUY" recommendation for Carvana Co. (CVNA), reflecting a positive outlook for the stock over the next 6 to 12 months. As of October 17, 2024, Carvana’s stock price stands at $191.92, with a target price of $222.00 in the medium term (6-12 months). The research highlights the company’s strategic initiatives, including the acquisition of ADESA’s U.S. operations, which has significantly strengthened its logistics and reconditioning capabilities. This, combined with a focus on operational efficiency and growth in retail unit sales, makes CVNA a compelling investment opportunity. However, it is essential for investors to conduct their due diligence, considering potential risks like elevated debt and macroeconomic uncertainties.

Key Stock Levels

Stock Price as of October 17, 2024: $191.92
Price Target (6-12 Months): $222.00
Recommendation: Outperform (Upgraded from Neutral on October 16, 2024)
Zacks Rank (1-3 Months): 2 – Buy
52-Week High/Low: $195.17 / $25.09
Market Capitalization: $40 billion

Investment Highlights

1. Acquisition of ADESA's U.S. Operations
Carvana’s acquisition of ADESA’s U.S. operations has substantially expanded the company's logistics, auction, and reconditioning capacity. Leveraging ADESA’s infrastructure, Carvana can now scale its refurbishment operations, enhancing both the quality and quantity of vehicles prepared for resale. This strategic move unlocks an additional 3 million units of annual reconditioning capacity, positioning Carvana for long-term growth in its used vehicle inventory.

2. Significant Growth in Retail Unit Sales
Carvana reported a 32.5% increase in retail unit sales in Q2 2024, indicating strong demand for its vehicles. The company anticipates a sequential increase in sales for Q3 2024. By focusing on operational efficiency and customer satisfaction, Carvana expects full-year 2024 retail unit sales to rise on a year-over-year basis, further supporting the bullish outlook.

3. Enhanced Operational Efficiency and EBITDA Growth
Carvana's focus on improving operational efficiency through technology, process innovations, and cost-saving initiatives has paid off. In Q2 2024, Carvana reported a record-adjusted EBITDA margin of 10.4%, up from 5.2% in the same period last year. For full-year 2024, the company projects adjusted EBITDA to range between $1 billion and $1.2 billion, significantly higher than the $339 million recorded in 2023.

4. Cost Reduction and Increased Retail Gross Profit Per Unit (GPU)
Carvana has successfully reduced its retail reconditioning and inbound transport costs, primarily through in-sourcing third-party services, logistics network optimization, and proprietary software development. These cost-saving measures have resulted in a 28.3% increase in retail gross profit per unit (GPU) in Q2 2024, bolstering the company’s bottom line.

Potential Risks

1. Elevated Debt Levels
As of June 30, 2024, Carvana’s long-term debt stood at $5.43 billion, compared to cash and cash equivalents of $542 million. The company's high debt-to-capital ratio of 0.98 significantly exceeds the auto sector's average of 0.57, which may restrict its ability to pursue further growth opportunities. Investors should remain cautious about the company's financial leverage, as it could affect Carvana’s flexibility in navigating future challenges.

2. Inventory Constraints
Carvana’s current inventory levels remain below its desired threshold, limiting the selection of vehicles available for sale. This scarcity of inventory could negatively impact sales volumes in the short term, as the company may struggle to meet consumer demand efficiently. Addressing these inventory constraints is critical for Carvana to maintain its competitive edge in the market.

3. Macroeconomic Headwinds
The auto retail industry is inherently cyclical, and Carvana is not immune to macroeconomic challenges such as rising interest rates and economic uncertainty. While vehicle demand has remained robust so far, it is unclear whether consumers will continue to purchase high-ticket items like used cars in an environment of elevated interest rates. Additionally, increased competition in the used car market could lead to price pressures, potentially affecting Carvana’s profit margins.

Segmental Performance and Financial Overview

Retail Vehicle Sales:
In Q2 2024, retail vehicle sales amounted to $2.41 billion, up 22.9% year-over-year, driven by higher-than-expected sales volumes. The number of vehicles sold to retail customers rose 32.5% to 101,440 units. The gross profit from retail vehicle sales increased 70.1% year-over-year, with a retail gross profit per unit of $3,421, significantly higher than in the previous year.

Wholesale Vehicle Sales:
Wholesale vehicle sales totaled $720 million in Q2 2024, down 7.3% year-over-year. However, the gross profit from wholesale sales rose 36.9%, reflecting improved unit economics. Carvana sold 50,368 vehicles to wholesale customers in Q2 2024, an 8.4% increase from the prior year.

Other Sales and Revenues:
Other sales and revenues, which include automotive finance receivables, rose 21.3% year-over-year to $279 million in Q2 2024. Gross profit for this segment declined 8.5% year-over-year, but the company expects additional revenue streams from value-added services to drive future gains.

Financial Position:
As of June 30, 2024, Carvana held $542 million in cash and cash equivalents, with long-term debt of $5.43 billion. Despite the elevated debt levels, the company’s ability to generate positive cash flow from its core operations and its growing retail GPU provide some financial stability.

Outlook and Valuation

Carvana is poised for continued growth, with a projected increase in retail unit sales for Q3 2024. The company’s adjusted EBITDA is expected to range between $1 billion and $1.2 billion for full-year 2024, a significant improvement from 2023. Furthermore, the stock is currently trading at 2.62X forward 12-month sales, which is favorable compared to the industry average of 1.69X. With a price target of $222.00, Carvana’s stock has the potential to outperform the broader market over the next 6 to 12 months.

Conclusion and Investor Actionable Insights

Carvana's strong performance, coupled with strategic acquisitions and cost management initiatives, makes it a promising investment. The Zacks recommendation of "Outperform" signals a potential upside for investors, especially with the stock's target price of $222.00. However, the company’s high debt levels and inventory constraints pose risks that should not be overlooked.

Investors are advised to conduct their own due diligence before making any investment decisions. While the outlook for Carvana remains positive, it is crucial to assess individual risk tolerance and market conditions when considering an investment in the stock.