How to play the eventual pop in the used car market

[Ridn2lo]

What’s up everyone. Been quite busy for the past few months with work, but things are slowing down and I can finally get back to doing more trading/DD contributions. Today I want to talk about the current used car market, my predictions, how I plan on playing the market in the future, and just have a general discussion thread for anyone else that may be keeping their eyes on the industry.

So for months I’ve been awaiting for the bubble to burst on the used car market. Used car valuations accounted for a nice percentage of our outrageous CPI numbers in the past months. Valuations on used vehicles skyrocketed over the course of the pandemic due to limited supply of new vehicles being produced due to lock downs. This is something that auto makers are still suffering from to this very day due to multi-month wait times on new vehicle orders. And when those new cars actually can be produced, people are seeing outrageous price markups from dealers as adjustments to the valuations of the current market. And with this, the market has set it self up for a major downfall I believe.

You know how student loans have been pushed back for now years due to this $1.7 trillion dollar problem lingering over people’s head because of fears of defaults? Well guess what: the current auto loan amount nationwide totals up to about $1.4 trillion. What’s really scary is that number apparently accounts for only 1/10th of the mortgage loan market.

I’ve felt that people buying used/new cars over the last few years have unfortunately put themselves in a situation of seeing a huge depreciation in the value of said vehicle in the next few months, and in turn being very upside down on their purchase.

Experian released their " State of the Automotive Finance Market - Q1 2022" around the beginning of June 2022, and it seems it has confirmed a lot of my fears.

It seems that people not only have been borrowing larger amounts of a vehicle purchase, but it also appears that they have been taking out loans with insanely long payment periods. The interest collected on these amounts over that time period would be insane.

Because of these larger loans amounts being borrowed, the average payment has now reached over $500 for the national average. And that’s over a crazy long payment period also.

And because of this drastic increase in financing amounts combined with the current state of the economy, defaults are now on a steady rise.

With these kinds of numbers, I’m expecting the number of repossessions to start climbing. When that happens, auto dealers will be adding back into their inventories. But if the amount of repos start climbing, that could be a good indicator that used car purchase will also start to see a decline. Therefore, auto dealers will be sitting on that inventory, and slowly supply will start meeting (or even slightly exceeding) demand. And if this occurs, you can expect the increases in market prices to start falling. This in turn makes that dealer’s newly repo’d depreciating asset worth even less. And more than likely you’ll start seeing banks/finance companies selling these defaulted loans off like crazy because they prefer the liquidity for pennies on the dollar and don’t want to keep those types of assets on their books.

So with this information, I’m expecting in the next couple of months to see a hefty decline in earnings for CVNA, KMX, and VRM. I believe the used car market will begin slowing down drastically in the next month or two so will probably be setting myself up on a short/put position on some of these tickers. I only feel like worse news is yet to come.

I will say that I don’t believe the used car market will slow down due to deals people can get on new cars. Those markups over MSRP are still high as hell, and probably won’t see a major decline anytime soon. Not to mention all of the issues that major auto makers have been dealing with in the past year (Hyundai’s recall of 5 million cars for fire issues; Ford recalling Mach-E’s for losing power while driving, Broncos for roof and engine issues, etc; etc). So it’s not exactly like you are getting the best build quality out of new vehicles these days it seems. So put plays on Ford, GM, etc may not be out of the question in the near future also.

For the long term, I’ll probably be sticking some money into AAP (Advance Auto Parts) because I think parts stores will see a nice revenue increase from people attempting to keep their current vehicles on the road longer rather than replacing that they have done so easily in the past. The average age of used vehicles on the road increased over the pandemic from 5 years to 12 years, so there are a lot of older cars out on the roads now that will need to be maintained.

This is not financial advice and please do your own research.

[Ridn2lo]

Looks like CVNA is now offering co-signer financing in TX. Maybe it’s a new way for them to resale a car they repo’d from someone who defaulted on their original financing.

https://finance.yahoo.com/news/carvana-debuts-co-signer-financing-135400977.html?theme=2&color=2

[jjcox82]

Very accurate info however as devils advocate here. I personally don’t think there is this mythical used car bubble that’s about to burst. There will however be a slow bleed off in used car values. Which there already has been.

I do agree that VRM CVNA and KMX will be hurt by this but mostly because of their over paying the market for cars. It’s essentially being stuck holding the bag.

However long loan terms are no thing of the times. In 2007 I signed my first deal as finance manager at a dealer. It was an 84 month loan. And even 96 months was available then at select lenders. Obviously the astronomical difference is the elevated price of cars now. This in turn creates larger losses or defaults. Rates then were similar to what they are today maybe even a touch higher for an auto loan about 4.5 percent for 84 month loan.

I also witnessed first hand a previous auto bubble burst in 2008 with the GM and what’s now know as Stellantis (Chrysler Jeep Dodge) bankruptcy. I happened to be at Chrysler store at the time. Literally 75 percent of the staff didn’t cover their base salary for months and months straight. That’s nowhere close to the future now.

It is likely going to take years and years for the used and new car market to catch up with times and demand. My current store I manage is on roughly a 15 day turn used. That means that if I have 60 in stock I sell 120. Currently sitting at those numbers now and do about 110-120.

Repo rates are ticking upward however going back and looking at prepandemic levels they are actually still below so called normal levels.

There is definitely a play here on the mentioned tickers but wholly feel like it’s a valuation drop that needs to occur that’s likely pretty significantly down the road. However CVNA VRM KMX are already losing money so may not take as much of a drop to hurt them badly. Since they aren’t posting profits now.

[Ridn2lo]

Wanted to share a statement in regards to CVNA that came out a few days after this post that was given by Steel City Capital on 08/09 which seems to strongly back my argument against the company.

Carvana (CVNA) shares are up more than 100% from recent lows. The quarter was predictably poor: retail unit growth slowed to ~9% year/year and the company generated negative EBITDA of $230 million. What bulls saw in the report was growth in per-unit gross profit (GPU) and a reduction in per-unit SG&A which they interpreted as an inflection in the business and a sign that the march to profitability has resumed in earnest. I think they’re getting high on their own supply.

While there may be some continued improvement in the “metal margin” component of GPU, all-important finance
GPU is unlikely to return to 2020/2021 levels in the absence of the ABS securitization market heating up again. At the same time, bulls have latched on to the company’s so-called “stretch-goal” of SG&A reaching $4,000/unit by the fourth quarter of the year. Let me start by pointing out something that is being grossly mischaracterized: this “stretch goal” is being conflated with “guidance.” It is absolutely not guidance. I view “stretch goal” as a sort of squishy term management can use to offer some hope for the future while simultaneously protecting themselves from getting sued if (when) they don’t hit this target.

More importantly, I think there is a near-zero probability that the company comes anywhere close to this level of SG&A/unit. Notwithstanding all of the hype about cost cutting, like-for-like cash SG&A (ex. ADESA and one-time restructuring expenses) dropped from ~$690 million in 1Q’22 to $640 million in 2Q’22, a reduction of ~7.0%. Laudable, but nowhere near the levels required to reach the “stretch goal.” The challenge is that CVNA has pulled in its horns with respect to retail unit volume growth in order to preserve liquidity, but the path to SG&A of $4,000/unit requires a reacceleration of unit growth in order to leverage fixed costs. This is a case of “the trend is not your friend,” with alternative data points indicating unit volumes declined sequentially in each month since March. And with the pending $1.0 billion reduction of the company’s floor plan facility by the end of September, the type of unit increases required to hit the target look increasingly unlikely.

*What if there’s still fat to trim? Perhaps it’s plausible, but I think bulls need to be more intellectually honest about what would need to happen for CVNA to achieve its “stretch goal”. Let’s say the company successfully reduces like-for-like cash SG&A to $575 million, reflecting a 10% decline from 2Q’22. CVNA would need to sell an all-time high 143,750 retail units in 4Q’22, reflecting a reacceleration of year/year growth to ~27%. I’m not holding my breath. *

And lastly – what happens if CVNA doesn’t hit its SG&A targets? I estimate the company will burn through the vast majority of its available cash by the end of the year, setting it up for a liquidity event in in early 2023. There’s a reason a majority of CVNA’s bonds trade at distressed levels. Bulls are whistling past the graveyard.

There has been constant news recently for CVNA in regards to their new co-signer financing becoming available in multiple cities. I think they are just swinging for the fences hoping that something connects for them. The one positive that I think they have in their favor is the new student loan forgiveness. Possibly the relief of student loan debt could give then some safety against miss payments from customers, but a lot of people out there do have more bills than just auto loans.

[puttytangnutbags]

And too add to that, they are only giving 10k forgiveness from my understanding, although I haven’t looked at it much. I had over 60k in student debt when I graduated so if I hadn’t paid it back like an idiot, Biden would have dropped me down to 50k. Doesn’t free up much cash. I shopped at carvanna after my Kia busted but the 1k delivery fee and 20% interest loan sealed the hell no deal for me.

[Ridn2lo]

$10k in forgiveness for singles under $125k, or couples under $250k. You get $20k in forgiveness if you received a Pell Grant during school.

[puttytangnutbags]

Still isn’t wiping most folks debts out imo, seems like more of a “vote for me” play that will probably cost me 2k per year in taxes to now pay others debts. I’m a little salty on this one though. Agreed with carvanna is due for a drop though

[25]

S&P/Experian Auto Default Index

This might be something interesting to follow. Came across this in the comment section of some substack I was reading. Basically was talking about you might be able to get a good deal on a car q4 as they predicted repo’s would start to ramp up more then. This is slower and I believe it said only gets published once every 3rd tuesday of the month or something but still interesting to look at. Also just a decent indicator to look at for macro level stuff along with anything else not specific to car stocks. Something to note is the last year the rate has been steadily climbing but down on the 3, 5 and 10. Getting close to the 3 year though. Would that be the initial layoffs from lockdowns?
Edit: deleted description as I see it’s included in the link already lol.

[Ridn2lo]

Article just release a few hours ago stating that Carvana just got a nice extension on their lines of credit with Ally Bank and Ally Financial.

CVNA stock price saw a nice drop today after the Fed’s meeting yesterday. Investors are concerned about high interest rates limiting consumer spending since they will now be spending more money on top of the still high vehicle prices due to limited inventories. Average interest rates on auto loans have climbed nicely, and I don’t see an end anytime soon.

I’ve have been steadily scalping short shares on this for the last few weeks, but current share price I feel is being dictated more by SPY movements. As far as how much lower it could go, it does have a 52 week low of $19.45, but it respected that $28 price range strongly today. It is also down 91% in the last 12 months. We could just as easily see a pop back up to the low $30s where it has had support though so be weary if you decide to play this. It is very oversold on the RSI currently on the 4 hour chart and down.

[Ridn2lo]

Well the bubble popped today with the announcement of KMX’s earnings. It along with CVNA got it’s teeth kicked in hard seeing around 20% drops in both. Congrats to all that played this.

From here I may gather a few CVNA shares in the morning to scalp depending on PM and SPY’s movements. It tends to be influenced by SPY a good bit, but with the massive drop today there could a small rally back up tomorrow due to it’s meme following and given that it had close to 40% short interest against it today before the fall so there may be some end of week profit taking by shorts closing positions since their average price is around $50. KMX might also be worth keeping an eye on, but short interest on it lies at only 8% and it’s not as volatile in my opinion.