Touring Carvana’s Operations
Over the last month, we had to opportunity to visit two of Carvana's (NYSE: CVNA) facilities - one Carvana Inspection and Reconditioning Center (IRC) and one ADESA auction site. We came away feeling better than ever about the quality, sophistication, and integrity of the company's operations. And make no mistake - this is an operationally intensive business. Getting these elements right is how Carvana makes it retail products and, importantly, they determine the spreads Carvana can make on a transaction. Please read on for more details about our tours and see our previous post on Carvana for our thoughts on the power of its vertical integration.
Highlights from the IRC
The easiest high-level takeaway is that Carvana's inspection and reconditioning processes are excellent. They run every vehicle through robust, standardized inspection procedures, with excellent reporting and tracking systems so the team knows what comes next for each car.
The facility we toured had four inspection lanes, with each capable of running two shifts, and each shift capable of running at two different speeds (6.5 minutes per car or 13 minutes per car), depending on staffing levels which are dictated by inbound volume. The difference in speed comes from, for example, having four people check tires vs. two people check tires at a station, and so on, along each inspection station. This arrangement (4 lanes, 2 speeds, 2 shifts) gives Carvana the ability to vary its inspection capacity based on volume trends. If 100% is 4 lanes at 6.5 minute cycles for 2 shifts, they can also run 1 lane at a 13 minute cycle for 1 shift, which amounts to 1/16th of the total capacity (1/4 lanes x 1/2 speed x 1/2 shifts, although there are other nuances that make this calculation overly simplistic), and presumably they can change capacity in 5-10% increments with this setup. That said, it is easier to speed up a lane than it is to add a new lane, so it is not as simple as it sounds. Since none of the IRCs are running full right now, Carvana has a nice runway to increase volume and scale by increasing staffing levels.
At every stage of the inspection process, Carvana appears to be trying to kick a car out to wholesale if it doesn't meet the company's retail standards. If the team needs to paint more than 8 panels, the car goes to wholesale. If it needs too many mechanical repairs, it goes to wholesale. There was a clear, strong culture and process around analytically stepping through decision trees at each stage to ensure only the best cars make it to Carvana.com, and to make sure those that do make it through generate gross profit per unit (GPU) at or above their targets. If not, they get kicked out to wholesale. If Carvana decides to keep the car for retail (most make it through because most customer-acquired cars are tagged as wholesale or retail units before they are picked up from customers), it will ensure the car meets consistent quality standards.
Carvana has impressive equipment, facilities, and capabilities. They can work on every aspect of any car, and they do it all with their own associates. The team follows a 150-point checklist, does extensive reconditioning and detail work, and photographs cars in a very thorough and robust way. Their standardized processes and comprehensive capabilities ensure for customers that cars purchased from Carvana are the best quality they can be. It feels as close to certified pre-owned as possible. Carvana's reputation for selling rigorously inspected, high-quality cars should continue to grow as more consumers buy and sell their cars with Carvana. The company can win on many dimensions with customers - convenience, quality, value, selection, and more, but we hope and expect that the consistent, high quality inventory will shine through competitively.
Close observers of Carvana's wonder when the company will return to growth now that unit economics are positive and revenue/volume growth will drive significant operating leverage. When I asked the team there what returning to growth would look like, step-by-step, their answer was that they would: (1) get a signal from management that more volume is coming their way in the coming weeks/months, (2) soon after, hold a hiring event and start to onboard new talent, and (3) train the team to be ready to scale up within a few weeks. Of course, scaling up is not reaching full scale (all lines, fastest speed, both shifts) - that would take additional time. But if they can tweak capacity up in relatively small increments, they don't have to make huge bets ahead of time.
It was very clear from talking with the team on site that there has been a lot of work done across Carvana to share best practices, standardize the decision trees at critical junctures to optimize for quality and GPU, and make every stage of the workflow more efficient. Additionally, it was evident that Carvana has cleared out the third-party services that had helped them meet demand during the Covid surge. Carvana outlined these operational improvements in a recent IR slide, shown below. We got a pretty good view on the first three points on our tour.
Source: Carvana Investor Relations
Now, let's transition to our tour of ADESA Los Angeles.
Highlights from ADESA
We had the privilege of visiting ADESA Los Angeles during the Friday morning auction. It was an fun and energetic experience - particularly seeing the auctions live.
For a little backdrop on ADESA Los Angeles, auction volumes have fallen in recent years, but it's clear that they are starting to pick back up. At this site, there were about 7,000 vehicles in inventory, down from a peak of 11,000 but up from a trough of 4,000.
70% of inventory is supplied by financial institutions (repossessions, fleets, etc.) while the other 30% is auctioned on consignment from dealers. ADESA makes about $750-950 per car sold, depending on its price, services utilized, and other factors.
Walking through the lanes was a fascinating experience, especially with auctioneers talking a mile a minute at each of their stations. They each have their unique tone and cadence, some of which were pretty unreal! Auctions last 30-40 seconds, although interestingly the Tesla-only lane goes even faster. Even though there were plenty of people there, most of the sales were done online (they told me 70-80% of buyers are online). See the video below - it was recorded primarily to capture the audio, but you can also get a feel for the lanes.
ADESA Los Angeles has full inspection and reconditioning facilities. The full campus for ADESA Los Angeles does retail inspection and reconditioning for Carvana (some of the 200k of retail IRC capacity they acquired from ADESA), wholesale inspection and reconditioning for auction customers, vehicle storage, and auctions spread across five physical sites. The wholesale inspection process produces a list of repairs that could or should be done by ADESA at the discretion of the owner, pictures of all imperfections that arise from the inspection, and ultimately an AutoGrade rating (0 through 5) which helps buyers filter through the cars more easily.
Interestingly, the team said they were planning to implement Carvana's inspection lane infrastructure and procedures at this location - a great example of the companies sharing best practices. Additionally, they indicated that it would be possible to expand IRC capacity for Carvana's retail operations in the future. It doesn't seem like a near-term priority, but it is on the radar for longer-term planning. This seems consistent with Carvana's plans, and adding capacity to one of the country's largest metro areas where it had no legacy IRC capacity certainly would cut help reduce logistics costs.
I asked the team if ADESA lost any auction volume since Carvana acquired them, which was an investor concern at the time. They said there was a slight blip at first, but after everyone saw that Carvana buys and sells cars at auction just like everyone else, with no preferential treatment, it's back to business as usual.
A slide used in a recent investor relations presentation shows the opportunity for ADESA to make greater contributions to Carvana. See below:
Source: Carvana Investor Relations
While ADESA alone is not the primary value driver for Carvana, it was great to see the quality of the operation and especially the quality of the people working at the facilities. It was also encouraging to hear about Carvana’s ability to expand its local IRC capacity in the Los Angeles area.
Closing
It's always great to get away from the computer screens and go see our companies in the real world - especially for such an operationally intensive business with so many steps required to sell a car to a customer. It was especially good to get out and talk to the team on the ground about the operational improvements that have been driving significant improvement GPU in recent quarters. It's clear that the team has benefited from being able to focus intensely on catching up with all the rapid growth from the past and the disruptions from Covid, and they appear to be excited and ready for the next wave of growth. The culture at the company is very strong and the quality of all the team members we met was exceptional. Their confidence in Carvana’s future potential was unphased by the stock's volatility over the past two years.
Carvana has shown great results during its first two phases of its turnaround plan, with normalized GPU reaching best-ever levels. In the facilities we toured, operations were smooth and the local teams had great focus on quality, standards, and analytical decision-making that are essential for this operationally intensive business to scale without impacting the customer experience. These tours increased our confidence in management's ability to grow profitably and to achieve better GPU and EBITDA per unit at each volume interval compared to our expectations before the company entered its three-phase turnaround plan. We look forward to watching how the company navigates through its phases going forward and we feel confident that Carvana will return to its share-gaining ways soon.
