This afternoon (03/14/19) KBRA Ratings was first on scene in issuing a very thorough Pre-Sale report on the Carvana 2019-1 ABS. Gracefully, they have allowed us to republish some of the data. But you can find the full report here. Overall though, the Carvana Pre-Sale is more supportive to our thesis than expected, given preliminary ratings and that the issuance includes a lot of the deep subprime loans that were likely previously going to an unnamed receivable purchaser (this concerned investors).
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This afternoon (3/12/19) CVNA filed an ABS-15G for a due diligence report related to its first ABS - Carvana Auto Receivables Trust 2019-1. This is a massive catalyst that we have been waiting for, and candidly, it is occurring a year or two earlier than we were expecting (though we did find a hint in the 10-K). We think an ABS deal could serve as a double catalyst. First, it will significantly lower the funding cost of CVNA’s financing business. Second, IF the ABS is broad enough to include some of its Deep Subprime loans (Exhibit 5), it will fully dissolve a leading bear thesis that Carvana has been over-earning in its credit business with quasi related-party agreements.
General Motors disclosures should remind investors that GM has an interesting SOTP angle. While the 10K dropped language related to timing of Cruise Commercialization (we still expect this w/in the next 12-months), the company is clearly preparing for bigger things. Cruise employees and management are receiving Stock Options and RSUs that vest upon an IPO. On the negative side, GM also continues to disclose potential residual risks related to the bankruptcy of old GM (Plaintiffs want 30 MM additional shares for the GUC trust; GM will fight this at a March 11 hearing); The Takata recall could cost $1.2 bn (though GM is still seeking to avoid a recall).
Yesterday (2/27/19), after market close, CVNA reported Q4 results. Retail units grew 105% missing Cons by 8pts, while total $GP/unit of $2,131 missed Cons of $2,170. The FY 2019 retail unit guide was slightly below Cons but we think it was strong enough to satisfy investors given uncertainty around tax refunds. EBITDA margin guidance was 200bps below Cons at the mid-point, but we think that investors were bracing for a miss on margin guidance, and the guide still demonstrates significant leverage.
We expect the US Dept of Commerce to release a report this weekend asserting that automotive-related imports are a national security threat, thus authorizing the Executive branch to enact tariffs without Congressional approval under the Section 232 statute. We think actual tariff enaction is unlikely given widespread opposition from U.S. constituencies (Auto Dealers are politically powerful; even the UAW has not offered its endorsement). Nevertheless, general uncertainty during the 90-day post-report evaluation period could have stock implications: Slightly negative for U.S. Suppliers, negative for U.S. Dealers and Aftermarket Retailers, negative for non-U.S. OEMs, and neutral for U.S. OEMs.
The Market is bracing for challenges as we transition to 2019, including lower Auto Production (particularly in China and Europe during 1H19), higher Rates (which raise concerns about Mix, Pricing), the strong U.S. Dollar, Regulatory Content, unpredictable Government Policy/Tariffs, the burden of increased Spending on Technology with uncertain returns, and in some cases discontinued passenger car products.
Most major U. S. OEMs and Suppliers will provide 2019 guidance in mid- to late-January… at our Detroit Auto Show Conference (Jan 15-16), or when they deliver Q4 earnings late January/early February. Management teams are pulling these forecasts together now. And they are doing so amid an unusually large number of market uncertainties (i.e. China, Europe, and NA production; company specific concerns for Ford (China, UK), JLR (China, UK), GM (discontinuing models), and local Chinese OEMs (declining at a double-digit rate in their domestic market). Based on our discussions with Industry Management teams we suspect that most will incorporate an extra dose of conservatism into their 2019 Guides. We are fine-tuning our estimates for Lear, Visteon, and Autoliv as we intend to take the same tack (e.g. today, we are fine-tuning our 2019 net new business backlog estimates, initially provided in early 2018, to reflect updated market and FX assumptions). See pages 3-6 for more details.
The current auto sales run rate in China, if sustained, would imply a 10% sales/production decline in 2019. Europe won’t be easy either, as production headwinds spill into 1H19. The U.S. has been relatively strong, but we remain concerned about affordability headwinds. Given these uncertainties, we question why OEM/Supplier margin expectations are up from 2nd half 2018 levels.
This AM (12/4/2018), KMX announced the rollout of its new omni-channel offering that it’s launching in Atlanta. KMX plans for it to be available to a majority of its customers by Feb. 2020. In its FQ2 call, KMX said that it would bring this experience to a major metro market by year end; however, it did not name the market nor signal a timeline for a broader roll-out.
We came away from Carvana’s Investor Day with reinforced conviction in our Outperform rating and 3 key takeaways: 1) The company’s competitive advantages (structural, technological, and cultural) are larger than perceived; 2) The market opportunity is massive, and; 3) The business model has clear opportunities for significant margin expansion.
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