Steel City Capital recently released its Q2 2020 Investor Letter, a copy of which you can download here. During the second quarter of 2020, the fund returned 13.1% net of fees, while the S&P 500 Index was up 20.0%. You should check out Steel City Capital’s top 5 stock picks for investors to buy right now, which could be the biggest winners of the stock market crash.
In the said letter, Steel City Capital highlighted a few stocks and Carvana Co. (NYSE:CVNA) is one of them. Carvana Co. (NYSE:CVNA) is an online used car retailer. Year-to-date, Carvana Co. (NYSE:CVNA) stock gained 57.8% and on July 20th it had a closing price of $144.84. Here is what Steel City Capital said:
“I believe market expectations for Carvana (CVNA) are disconnected from what the company is likely to deliver, particularly as it relates to the next several quarters. One of the company’s key value propositions – purchasing a car from the comfort of your home with no direct human interaction – is tailor-made for a world of social distancing. After bottoming at $22.16, shares have risen 6.4x to their current level of $141. The market is expecting more from CVNA today than it did at the beginning of the year.
What I believe investors fail to appreciate is the company actually finds itself at a momentary disadvantage that should fully emerge in its third quarter results. Specifically, CVNA made a strategic decision to pull back on used vehicle inventory purchases in March and April in order to preserve liquidity. While the company has since resumed purchases, inventory listed on the company’s website remains far below levels exhibited earlier in the year. In turn, this will weigh upon future retail sales volumes. At an investor conference in June, CEO Eddie Garcia had the following to say:
“So we’ve historically had over 30,000 cars in the site. Coming out of coronavirus, we stopped buying cars for probably 45 days, give or take. And so our inventory today is smaller than that, but we plan to build back to that level and continue to build from there.”
“So I think – we quickly reacted when we saw the impacts that coronavirus was having. And so that included tightening credit, it included stopping buying cars from customers and buying cars in general. And so that clearly has had impacts. And the bounce back has been much faster than certainly I would have imagined. Whether it’s the bounce back in demand or the bounce back in vehicle prices, the bounce back in volume at auction. So I think that has positioned us to where we have less inventory than we wish we had today by, to be honest, a pretty significant margin. So I think we are working hard and we have work to do to build our inventory back up. That is clearly constraining sales versus what they would otherwise be.”
Various data service providers have pegged the number of units for sale on CVNA’s website at ~15,000 during the first two weeks of July. This compares to an average of ~31,500 in 1Q’20 when the company’s FY’20 sales guidance was for ~260,000 retail units. For the company to generate sales anywhere in line with consensus expectations, it will need to rebuild its inventory – and do it quickly. Unfortunately for CVNA, it faces unexpected headwinds in rebuilding its inventory position. Used vehicle prices have staged a stunning rebound, with Manheim reporting in mid-July that wholesale used vehicle prices sit 11.0% over last year’s levels8 . In fact, if the index holds for the full month of July, it will set a record high for the second consecutive month. So CVNA finds itself in a position where it must refill its depleted inventory at a time where wholesale used vehicle prices sit at an all-time high. This will likely prove to be a headwind to profitability – notable because the company continues to generate cash losses for each unit it sells.
For good measure, I updated the table included in the Partnership’s 1Q’20 letter that compared CVNA’s key financial and operating metrics to those of the nation’s largest used care retailer, CarMax (KMX). Despite CVNA’s reported results continuing to woefully lag those of KMX, the company has actually grown is valuation premium to $9.1 billion compared to “only” $3.0 billion in late April. Investors clearly have great expectations.”
In Q1 2020, the number of bullish hedge fund positions on Carvana Co. (NYSE:CVNA) stock decreased by about 2% from the previous quarter (see the chart here), so a number of other hedge fund managers seem to agree with Carvana’s downside potential. Our calculations showed that Carvana Co. (NYSE:CVNA) isn’t ranked among the 30 most popular stocks among hedge funds.
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Video: Top 5 Stocks Among Hedge Funds
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Disclosure: None. This article is originally published at Insider Monkey.