#023 - CarLotz

CarLotz is a unique business with a differentiated buying process. CarLotz uses a consignment business model for the majority of its inventory, but has a similar process as other used car retailers.

CarLotz - (NASDAQ: LOTZ)

CarLotz is a unique business with a differentiated buying process. CarLotz uses a consignment business model for the majority of its inventory, but has a similar process as other used car retailers.

If you enjoy this, sign up for more shallow dives here!


Please note that this article does not constitute investment advice in any form. This article is not a research report and is not intended to serve as the basis for any investment decision. All investments involve risk and the past performance of a security or financial product does not guarantee future returns. Investors have to conduct their own research before conducting any transaction. There is always the risk of losing parts or all of your money when you invest in securities or other financial products.


Industry Overview

The used car retailing industry is a massive and fragmented market with numerous companies trying to win market share. There are older existing companies such as CarMax trying to capture more market share and newer companies such as Carvana, Vroom, and Shift that are trying to out perform the “legacy” competitors.

If you want to get a more complete picture of the used car industry, feel free to read through my shallow dives on Carvana and Vroom. These companies buy cars from wholesale auctions, from consumers, or through other sources and try to fix these cars up and sell them to consumers.

Business Overview

CarLotz is an interesting business. I’ve enjoyed researching it this past week. It has a slightly different business models than some of its competitors like Carvana, Vroom, CarMax, and Shift. CarLotz combined with Acamar Partners Acquisition Corp to go public through a SPAC. CarLotz officially started trading under LOTZ in January 2021.

Like I said, CarLotz is a little different of a beast than its competitors. CarLotz has the typical business model of selling cars to consumers, but the buying process is unique. CarLotz utilizes a consignment model for the majority of its inventory. CarLotz works with corporate souring partners for ~60%+ of its inventory. These are companies like OEMs, banks, or other large corporate businesses that want to sell used cars to consumers.

Typically these customers could sell vehicles either through an auction process to consumers (basically retail sales) or through wholesale. CarLotz adds value by being able to offer better prices because it removes some of the inefficiencies in the supply chain. All stakeholders win when these corporate partners sell to (or cosign inventory to) CarLotz. Sourcing partners get a better price. Consumers get cheaper vehicles. CarLotz collects some revenue.

Here is an example of this process from the management team:

“This is a vehicle that would sell at an auction for $19,700, so net of fees. The auction would cut a check to the seller of this vehicle for $19,370. This is a vehicle we sold for $23,000. So net of our fee, which is about $1,000. And in this case, reconditioning, transport, gas to the tune of $952. Next, our client, $21,048. So $21,048 less what they would have gotten an auction, $19,370, gives them a lift on this vehicle of $1,728.”

The most interesting part of this business was the ability to have an asset-light source of inventory. CarLotz is able to avoid inventory problems and other risks associated with holding inventory that other competitors might face.

“Competitors that own their own inventory, typically have hundreds of millions, in some cases, billions of dollars of inventory on hand, which is at risk. If there's a pandemic or something else that slows down sales, that's inventory which is getting devalued and that's inventory you own. So very risky.”

— Michael Bor (Co-founder and CEO at Carlotz)

LinkedIn

CarLotz Presents at ICR Conference 2021, January 2021

CarLotz also relies on other typical inventory channels such as from trade-ins, straight sales from consumers, or through buying at auctions. CarLotz does take on some inventory risk when some consumers don’t want to sell via CarLotz’s consignment business model.

The rest of CarLotz business, selling business to consumers and selling through wholesale, is the same as other competitors.

CarLotz has four strategies to expand and grow.

  1. New hubs each quarter. Management is projecting an increase of 3-4 hubs per quarter.

  2. Sell-through. CarLotz wants to increase its sell-through rate (being able to turn inventory quicker).

  3. Increase average selling price.

  4. Increase F&I penetration. Other companies have strong F&I income and CarLotz likely sees this as an avenue of high gross margin revenue (effectively 100%).

CarLotz utilizes its own reconditioning centers and doesn’t rely on working with 3rd parties. CarLotz also works to ship vehicles to consumers and uses its own logistics for trips within 50 miles and outsources this process with trips over 50 miles.

Total Addressable Market

This section hasn’t really changed over the last couple of weeks. Basically e-commerce penetration among the used car market is tiny. Bullish investors think the market for buying and selling used cars online should be an order of magnitude greater than it is today. Due to CarLotz different buying process, management says that there are 12 million vehicles sold through corporate sources and if CarLotz can be the main retailer to sell these cars, that could be very beneficial for CarLotz. Besides that though, there are many similarities between CarLotz and the other companies mentioned like Vroom, Carvana, Shift, and Carmax.

Currently, the total used car market is massive with most sources estimating the TAM above $750bn. Assuming 40 million used cars are bought and sold every year, slap on an average selling price of ~$18,750 and we can back into an estimated TAM of $750bn. Of course there are probably some fluctuations in the market size depending on whether or not you include financing or other revenue opportunities. Also would highlight that this industry doesn’t lend itself to high gross margins because of the buying and selling of cars which there isn’t much markup on.

One interesting quote from Carlotz’s management team which said:

“But the used -- one of the things we love about the used vehicle market is that it is remarkably steady at the consumer demand side. In almost any economic climate, there are 40 million cars that sell, and we've seen that over several decades. And in a bad market, maybe it will drop to 39 or 38. In a good market, it will go to 41 or 42. But it really stays within that tight band.”

— Michael Bor

CarLotz Presents at ICR Conference 2021, January 2021

I don’t think I have anything else to add to this section this week. I think it’s pretty self-explanatory (or at least I’ve already explained it) so I’ll save you some time. If you are a new subscriber, feel free to read through my shallow dive on Carvana and Vroom if you want to learn more about this industry and why the TAM is estimated to be so massive.

Competitive Advantages

  • Scale

    I’ve been saying this for weeks now, but I do think that scale is the strongest competitive advantage in this space and something that these companies will need to survive and thrive.

    For example, used car retailers with scale can have cheaper shipping prices because of the density of the hubs and different retail locations. If shipping is cheaper, then this retailer can offer lower prices or match the price as a competitor without the less expensive shipping. The used car retailer with cheaper shipping will either be able to offer better prices for consumers or reinvest in its business with higher profits.

    Better prices for consumers leads to more demand which might feed more purchases and therefore better scale over time. Higher profits can be reinvested in the business to grow scale and build more hubs.

  • Corporate sourcing partners

    I think this could be a competitive advantage for CarLotz. It’s definitely unique and I haven’t come across it so explicitly among the other companies I’ve looked into. If these corporate sourcing partners and CarLotz are joined at the hip through the various processes of selling a car, then maybe it keeps competitors like Carvana out.

    Here is a quote from one of CarLotz’s earnings call that discuss the work that goes on between CarLotz and its' corporate sourcing partners:

    “We have business intelligence and data analytics to help [corporate sourcing partners] figure out how to triage vehicles between wholesale and retail, which ones should come to us, which ones should go straight to wholesale, depending on what's selling well at retail and what has high consumer demand, low consumer demand, conditions of vehicles, et cetera.

    We have very wholesome reporting that enables our clients to look by year, make, model, mileage band, reconditioning totals and figure out what makes the most sense for retailer marketing and what should be sold at wholesale. We've also created proprietary condition reporting apps that gives our clients a tremendous amount of detail into the condition of their vehicles because oftentimes, we're picking up the vehicles and selling them without our clients having seen the vehicles. These are vehicles that are being driven by our clients' clients. And so having a good sense of what their condition is, at the time the vehicle is returned, helps them bill back charges that may be required to get the vehicle into good shape.”

    While of course some of this might just be management spilling a story, I’m not trying to pitch you an idea or recommend that you invest in this company. I’m writing about what I find interesting and if I were to study these companies more in-depth these are some of the areas I’d look to research and have an answer for.

Financials

CarLotz has some impressive goals that it wants to accomplish. CarLotz is aiming to do $1.5 billion in revenue in 2023. By building more hubs, increasing scale, and reinvesting in the business, management is optimistic about accomplishing this target.

CarLotz recognizes retail gross profit per unit as (retail vehicle gross profit + finance and insurance gross profit) / retail unit sales. CarLotz’s finance and insurance revenue is also 100% gross profit.

2020

  • Retail vehicle sales = ~ $104,253

  • Finance and insurance sales = ~ $3,898

  • Retail vehicle gross profit = ~ $7,270

  • Retail units sold = 6,215

  • Retail gross profit per unit = ~ $1,797

  • Number of hubs = 8

  • Retail revenue growth = 15.3%

  • Finance and insurance revenue growth = 25.1%

  • Retail gross margin = 7.0%

  • Percentage of sales via consignment = 66.0%

2019

  • Retail vehicle sales = ~ $90,382

  • Finance and insurance sales = ~ $3,117

  • Retail vehicle gross profit = ~ $5,848

  • Retail units sold = 6,435

  • Retail gross profit per unit = ~ $1,393

  • Number of hubs = 8

  • Retail revenue growth = 69.1%

  • Finance and insurance revenue growth = 93.8%

  • Retail gross margin = 6.5%

  • Percentage of sales via consignment = 46.0%

2018

  • Retail vehicle sales = ~ $53,448

  • Finance and insurance sales = ~ $1,608

  • Retail vehicle gross profit = ~ $4,925

  • Retail units sold = 4,077

  • Retail gross profit per unit = ~ $1,602

  • Number of hubs = 8

  • Retail gross margin = 9.2%

  • Percentage of sales via consignment = 41.0%

On the surface, I’m disappointed in the growth in 2020 but understandable when looking at how much the world changed in 2020. Also disappointing that CarLotz hasn’t grown the number of hubs in the past couple of years but that is a focus for them going forward.

What’s Interesting

  • In-house reconditioning centers?

    “We also are adamant about being in control over the quality of the vehicle. And so we see quality is much better when we handle it ourselves. Also, if a client comes back or wants to exchange the vehicle or has an issue post sale, we can handle it much better when we are managing the process. So we view having total control over reconditioning to be a key part in the markets outside of Virginia, to be a key part of this 84 NPS score we're offering to our clients. Because it gives us the ability to really control the process and the quality of the vehicle that we're selling.”

    — Michael Bor

    This isn’t necessarily an interesting point for CarLotz specifically but more so for the rest of the industry. There’s some discussion about the need for companies to have its own reconditioning centers and whether or not this is an efficient use of capital, but so far Carvana, Shift, CarMax, and now CarLotz all recommend and embrace having in-house reconditioning centers. That’s not a great look for Vroom (which doesn’t have its own reconditioning centers).

  • Corporate sourcing partners

    While other used car retailers likely buy from these corporate sources, CarLotz seems to be rather close with some of these partners. These sources contribute roughly 12 million used cars a year to the 40 million total unit sales. CarLotz doesn’t need to capture a significant portion of these units in order to have tremendous results. While these partners sell through wholesale and retail channels, CarLotz might be able to capture enough unit sales in order to drive impressive financial results.

Future Questions

  • Stickiness of corporate sourcing relationship?

    I think this is an interesting aspect of the business like I’ve already touched on. I think this could be a massive benefit and is a differentiating factor for CarLotz when compared to other companies. If CarLotz can even crack 1% of the 12 million unit sales, CarLotz will likely have massive success. This is much easier to say than do, but it’s also not impossible given CarLotz already has this relationship established.

  • Hub growth?

    I think this is the primary driver of CarLotz and management understands that and is looking to expand the number of hubs across the country. Growing hub locations helps to increase density, decrease costs (such as shipping), and improving the number of consumers that CarLotz can reach. I don’t think is a very differentiated factor compared to CarLotz’s competitors, but I do think it is important for this business to succeed and reach its $1.5 billion revenue goal for 2023.

Conclusion

I’m not sure how I feel about CarLotz. I like some parts of the business but I also worry about CarLotz’s lack of existing scale and whether or not some aspects of this business are truly differentiated and whether or not CarLotz will have a sustainable competitive advantage going forward. At some price (I don’t know what number) this might be an attractive opportunity purely based off the risk/reward ratio, but I don’t have a price target.


If you’ve enjoyed this edition of Weekly 10-K please considering subscribing below, sharing it with friends and colleagues, or following me on Twitter.