ACVA - ACV Auctions: Macro Tailwinds Ahead To Continue Driving Growth

2023-12-07 18:21:38 ET

Summary

• I continue to recommend a buy for ACV, As I believe it can achieve its FY26 targets.
• ACV has shown strong performance with gains in market share and revenue growth, despite a contraction in the industry.
• The company is expected to benefit from macro tailwinds, such as improved vehicle sales and increased demand for used cars.

Investment action

I recommended a buy rating for ACV Auctions (ACVA) when I wrote about it the last time , as I expected ACV to grow alongside the growing online adoption in the automotive industry. Based on my current outlook and analysis of ACV, I recommend a buy rating. I continue to believe ACV will be able to achieve its FY26 targets, especially with the upcoming macro tailwinds and ACV's ability to continue capturing share. With ACV proving that it can improve its EBITDA margin and grow, I think it should trade at the same level as KAR in FY26.

Review

It's been awhile since my initiation on ACV. My previous price target was $12.97, which reflects the upside case if ACV can achieve its FY26 targets. Splendidly, the stock performed very well against a strong fundamental performance, driving the stock price up to near $19. I believe the timing is right to give this ticker an update. In 3Q23 , it reported revenue of $119 million, and non-GAAP gross profit saw $59 million and gross profit per [GPU] unit of $393. This led to an overall adjusted EBITDA loss of $4 million, a margin of -3.1%.

I believe ACV continues to perform very strongly, as reflected by its continuous gains in market share and revenue growth. While market share expansion has slowed, it is still capturing share in the mid-teens range (management estimated 15%). Importantly, this was on the back of an industry contraction of 2%, which further indicates the resilience of ACV's business model and how strong the online adoption secular uptrend is supporting growth. I expect ACV to continue capturing share through its strong product innovation ability and consistent improvements to its data offerings. The reason I mention this is because they allow ACV to expand their relationship with dealers, which increases the product bundling potential and allows ACV to win more wholesale volumes. Volume is a key piece in the ACV network effect, as more volume drives higher profit growth (high incremental margin since underlying infrastructure is fixed), which provides more dry powder to reinvest in the business (improved data offerings), which increases the value proposition to dealers (dealers can leverage ACV increasing set of data to generate condition reports to better visualize the car’s condition), which drives more dealers to adopt ACV's solutions.

Looking ahead, I also expect ACV to benefit from the macro tailwinds. For instance, new and used vehicle sales should improve in 2024, increasing ACV's revenue opportunity. New vehicle inventories are at their highest levels in recent years , which should drive an increase in OEM incentives to drive more volume sales. What happens from this process is that used car owners will be more likely to buy new cars (if the credit condition does not worsen). So what happens to used cars currently? They will be pushed into the wholesale/resale market, where ACV will benefit. Since the used vehicle market has remained weak and there is expectation that the Fed might cut rates for 2024 , pent-up demand for car purchases could be unleashed in 2024, which, combined with the easy growth comparable to 2023, ACV could potentially see strong growth acceleration. This could be a positive catalyst for stock sentiment.

If we look at management guidance, the outlook points to a similar conclusion, as it implies another sequential acceleration in revenue. Specifically, management 4Q23 revenue guidance implies 20% growth, which is an acceleration from 8% in 2Q23 and 13% in 3Q23. As I discussed above, I think this guide is fair, and it should be driven by unit growth.

Valuation

The way I modeled ACV previously was based on management FY26 targets. I still think this is the best way to value ACV, as the business will be generating meaningful EBITDA at that point. With the upcoming macro tailwinds and ACV's ability to continue capturing share, I believe it is on track to deliver against this guidance. As revenue grows, incremental margins should drive margins upward. Now that ACV has shown that it can continue to capture share and improve EBITDA margins, I now expect ACV to trade at the same valuation as OPENLANE ( KAR ) in FY26. Comparing both businesses, by FY26, ACV will have a similar amount of revenue to EBITDA that KAR is generating today. As such, I don’t see a reason for ACV to trade at a discount.

Risk and final thoughts

An implied growth assumption I made was that the macro condition would not deteriorate from here. If rates were to go higher, car buyers may continue to delay their purchases as financing costs get more expensive. This could negate the positive impact of the car inventory situation. Accordingly, this would delay ACV growth momentum, making it harder to achieve the FY26 target.

Overall, my final thoughts are that ACV still deserves a buy rating. The business has continued to capture market share, and show solid revenue growth. I believe growth will continue as there are visible macro tailwinds ahead. Management's guidance also suggests a continuing acceleration in revenue, signaling positive growth trends. Valuation-wise, I believe ACV should trade at the same level as KAR as both business should have a similar revenue base and margins in my view.

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