Historically, roughly 40 million used (or “pre-owned”) cars are bought and sold at the retail and wholesale level in the United States each year, making the size of the market roughly 2.5x that of new units, and generally less volatile. This fact is owed not only to its size but also the concept that used vehicles act as substitutes for new cars. When consumers have lower confidence in both their personal as well as the broader economic outlook, the used car market is often sought as the market of choice to replace vehicles.
Table 1 US Used Vehicle Sales
Source: Public data
Traditionally a relatively predictable market, the impact from COVID is still being felt throughout the used car ecosystem, as supply chain challenges for new vehicles and a lack of availability of low mileage pre-owned vehicles remain challenges that retailers and wholesalers will likely continue to face through the end of 2023 and into 2024.
Markets have anticipated the coming rebound to a degree, as CarMax (KMX) shares have rebounded to $86 (+38%) while heavily shorted Carvana (CVNA) shares have skyrocketed from bankruptcy concern-related lows to $40, up more than 6-fold this year.
Shares of franchised auto dealers such as AutoNation (AN) and Penske (PAG) are up 65% and 55% respectively, as stronger performance than anticipated for both new and used vehicle profitability has surprised investors.
USED CAR VOLUMES – Nearly through the Nadir
Used car volume have been unnaturally volatile over the past 2.5 years. The initial lack of new vehicle inventory, coupled with COVID-driven stimulus checks and low-interest rates sent consumers to the used vehicle market in droves – most notably in the 1-4 year old “gently pre-owned” market. Used vehicle prices naturally skyrocketed, as the above conditions persisted throughout 2021 and well into the latter half of 2022.
During that time period, the available supply of high-quality, affordable used vehicles dried up as well. Low production levels for new vehicles in 2020 and 2021 reduced the available population of younger new vehicles. Considerable price inflation for what was available in the new vehicle market impacted affordability to a degree, leaving consumers holding on to younger pre-owned vehicles longer than they would have otherwise. Further, leasing (typically 20-30% of new vehicle sales) effectively stopped nearly altogether as well, as unpredictability of used vehicle prices led to extravagant monthly payment offers.
Table 2 Major Used Vehicle Retailer Volume Growth, YoY, 4Q19 to Present
Source: Company Filings
As illustrated on the previous page, performance varied greatly between online-only platforms such as Carvana’s, more traditional retail with omnichannel capability in CarMax, and traditional franchised dealers such as AutoNation. Carvana’s considerable growth deceleration, coupled with declines in gross profit per unit, helped drive the stock from $300 to $6 before its recent rebound.
For volumes to rebound from current levels, the following will likely be required.
– Increased new vehicle supply to spur more new sales and avail more trade-ins to the marketplace. Exhibit 1 (below) estimates the size of the 1-4 year old car population – a critical sourcing area for major used vehicle retailers such as CarMax and Carvana. Low new vehicle sales in over the past three years have effectively reduced the available population for low-mileage, high content cars desired by retailers. The good news for these participants is that the inflection point on volumes likely occurs next year, with the potential for considerable growth thereafter.
– Further declines in used vehicle prices to improve broader availability (discussed more below)
– Greater consumer confidence
Exhibit 1 1-4 Year Old Car Population
Source: Ward’s Auto, Gabelli Funds estimates
USED CAR PRICES
The circumstances described in the section above conspired to drive used vehicle prices to all time high levels. Manheim’s Used Vehicle Value Index is cited as the industry standard for understanding movements in wholesale prices on a model, mix, and year-adjusted basis. As noted (below/above), the index spiked early in 2020 and has stayed elevated in the interim. While prices have declined from all-time highs, Exhibit 2 (following page) shows that wholesale cost remains well above historical trend and considerably greater than pre-COVID readings. On the surface, higher used prices typically allow greater profit uplift; however, the velocity of the movement created myriad challenges for industry participants.
Exhibits 2 and 3 Manheim Used Vehicle Value Index, 1997-Present and 2019-Present
Source: Manheim
REVENUE PER UNIT IMPACT
Greater wholesale prices mirrored the rise in used car prices for retailers. Table 3 (below) illustrates the massive moves in revenue per unit at major used retailers over the past four years, with CarMax most notably seeing prices rise from the $20,400 level to the current market, over $27,200.
Table 3 Major Pre-Owned Vehicle Retailers Revenue Per Unit, 4Q19-Present
Source: Company Filings
Exhibit 4 Major Pre-Owned Vehicle Retailers Revenue Per Unit, 4Q19-Present
Source: Company Filings
While prices have declined for the past several quarters across the board for used car retailers, per-unit revenue remains well above pre-COVID levels.
Retailers, in general, would like to see prices reasonably and steadily decline further as availability improves and volumes can reaccelerate.
GROSS PROFIT PER UNIT IMPACT
Massive increases in revenue per unit did not necessarily come with commensurate increases in unit profitability. Table 4 (below) depicts the march from normalized profit at the end of 2019 to the first quarter of this year.
Table 4 Major Pre-Owned Vehicle Gross Profit Per Unit, 4Q19-Present
Source: Company Filings
Retailers chose to handle changes in used vehicle prices in dramatically different ways.
– CarMax chose to maintain gross profit per unit both in rising and declining used vehicle price markets. After an initial decline to $1,937 during the original months of COVID, KMX has maintained gross/unit in the $2,100-2,200 range until its most recent quarter (when the decision to sell a greater number of older vehicles resulted in used GPU at $2,361. The results, as best illustrated in Exhibit 5 (below), has been a steady (and more predictable) profit stream – a results of the company’s maniacal focus on holding gross in the face of revenue per unit volatility
– Carvana, on the other hand, has struggled to maintain gross per unit discipline as its volumes have declined. Using CVNA’s retail GPU disclosure, profit per unit has fluctuated wildly, from as high as $2,022 in 2Q21 to just $425 in 4Q22. Recent optimism on rebounded GPUs has no doubt been a component of the company’s short squeeze from $6 to over $30/share. A victim of its own early success to a degree, CVNA has, several times now, been impacted by periods of “over-buying,” leaving it with too much inventory in less convenient locations for online delivery. The company has had to reset earlier strategies and become more focused on regional efficiencies to deliver value to customers.
– Similar to CarMax, AutoNation has (wisely) sought to preserve per unit gross despite broader volatility in both volumes and per unit revenue. The company continues to focus on keeping gross degradation to a minimum – a strategy to this point that has proven beneficial to the company and to shareholders (AN is up nearly 70% this year to $170 from $100).
Exhibit 5 Major Pre-Owned Vehicle Gross Per Unit, 4Q19-Present
Source: Company Filings
Exhibit 5 (left) clearly depicts CarMax’s strategy to keep GPU (gross per unit) steady in the face of volume and price fluctuations.
Carvana’s operating struggles are more apparent given this visual as well.
Table 5 Major Pre-Owned Vehicle Gross Margin Per Unit, 4Q19-Present
Source: Company Filings
Exhibit 6 Major Pre-Owned Vehicle Gross Margin Per Unit, 4Q19-Present
Source: Company Filings
Exhibit 6 (left) shows the margin degradation from the changes in gross per unit amidst rising used vehicle prices.
Cavana’s struggles throughout this period are most apparent, while the performance of both CarMax and AutoNation shows a more stable but still steady decline. Recent rebounds are encouraging and augur well for coming quarters.
WHAT’S AHEAD FOR RETAILERS?
The known issues previously mentioned provide context for what we can expect through the end of 2023 and into 2024. Volumes (absent any changes in share) are likely to bottom out over the next twelve months and set up for a strong recovery. Similarly, increases in new vehicle availability could potentially spur greater trade-in supply for used car retailers, allowing more product to be purchased and ultimately retailed to consumers.
– CarMax is likely to be the least disrupted by further changes to the market, as the company’s commitment to Gross Profit per unit preservation has enabled stronger cash flows and a further strengthening of market position.
– Carvana 2Q earnings will be closely watched, as investors and analysts will focus on quality of performance, excluding more one-time items such as gains on the sale of securitized loans. Importantly, the company carries more than $6 billion in debt (with interest expense upwards of $600 million annualized). The rebound in shares has likely created an opportunity for an equity offering to buy more time before operations can be turned around – though some equity swap resolution for debt holders will likely be required.
– Similarly, performance for Vroom (VRM) will likely hinge on whether the company has truly reduced costs to a meaningful level to be able to profitably grow in 2024 and beyond.
– For franchised dealers such as AN and PAG, we expect continued strength in profitability throughout all parts of the business (New, Used, Finance & Insurance, Parts & Service), as lower inventories allow for stronger performance from the core new sales portion of the business.
IMPACTS ON THE AUCTIONS?
Wholesale auctions allow dealers and other commercial vehicle owners such as rental companies and captive finance companies, to sell “un-wanted” vehicles. According to Cox Automotive (formerly Manheim), dealers accounted for 6.0 million of the total 8.9 million wholesale volume in 2022. Dealers attempt to optimize inventory by maintaining vehicles on their lots that will sell the quickest at the highest prices. Vehicles’ make, year, and dealership region will influence these variables. Upon receiving a vehicle from a trade-in (including off-lease), a dealer may choose to auction off that vehicle if they do not believe the vehicle will sell well, or the reconditioning is too costly, etc. That vehicle may sell better on a different dealer’s lot. Auction platforms such as Manheim and Kar Auctions help reduce the friction of dealers optimizing their inventories. Other sources of vehicles include repossessions, rental, and other fleet vehicles that have reached a predetermined age or mileage.
Wholesale auction volumes plummeted between 2019-2022, falling from 13.5 million to 8.9 million, in response to the aforementioned low inventory across the new and used vehicle eco-system and the subsequent high prices (Exhibit 2). A large portion of the 35% volume decline stemmed from the low volume of off-lease vehicles. Off-lease vehicles fell from approximately 2 million vehicles in auction to under 500,000 as lessees kept their vehicles instead of replacing them with a new lease due to the significant increase in costs (costs of leases were higher as new/used vehicle prices increased, higher required deposits, etc). Overall, dealer lots remained sparse and demand outpaced supply driving up prices. In tandem with the fact that fewer owners were bringing in their used vehicles due to the higher costs of buying a new vehicle, dealers could sell any vehicle that landed on their lots, with little required conditioning, as demand outpaced supply. This reduced any incentive for dealers to go to auction as buyers bought what was available, inventory remained low reducing any pressure on holding costs/capacity, and prices were high.
Going forward, it appears as if we hit bottom in 2022. Manheim expects auction volumes to bounce back by 6-7% in 2023 as inventories improve and new/used vehicle prices come down (wholesale vehicle values fell 10.3% YoY in June) (Exhibit 3). A significant portion of the recovery will be an estimated +65% growth in off-lease volume (still down 78% from 2019 levels) and improvement in repos (repossessions are generally auctioned off). Any sign that prices are declining has been taken as a positive from the market as it signals positive volumes going forward. We note that conversion rates at the auction market remain low as many sellers are not yet ready to accept the lower bid by buyers. However, this is temporary friction in an overall efficient market.
Exhibit 7 Estimated Wholesale Volumes by Inflow Channel (Annual volume, million units)
Source: Manheim, Cox Automotive
