CVNA - Vroom Q2 Earnings Preview: A High-Risk High-Reward Play Priced For Bankruptcy

• Vroom's Q2 report on Monday is a first test of its realignment plan as management works to cut costs and improve GPPU, EBITDA, and liquidity.
• Normalization in the used car market could see strong demand combined with higher pricing power lead to upbeat results on revenues and volumes.
• GPPU may feel the effects from transportation and retouching costs from high fuel and logistics costs and a strained auto parts market.
• However, Vroom has shown an ability to mitigate declines in GPPU, compared to rival Carvana, and could see 4-6% sequential improvement in GPPU.
• Bankruptcy fears have been prevalent, and failing to show improvements in GPPU, EBITDA, and cash burn are only likely to increase these fears.

Used car retailer Vroom ( VRM ) has seen shares battered during the course of the year, falling over 90% as bankruptcy fears loom. Vroom has shown accelerating losses, and has set in motion a turnaround plan in motion to improve gross profit per unit [GPPU], decrease cash burn and operating expenses, and aim to maximize profitability. Hitting all of these targets in the long-term should position Vroom to reach 5% to 10% positive EBITDA margins, per management's plan. Although risks do arise from Vroom's indebtedness and potential bankruptcy, sequential improvement possible in Q2 -- should Vroom show a three-quarter improvement in EBITDA and GPPU gains -- sets up a high-risk, high-reward play.

Realignment Plan

Vroom dove deep into its realignment plan to improve GPPU by slashing costs in an effort to prioritize profitability, as losses have accelerated in recent quarters. Vroom's problem lies in overspending -- Q1 showed a 70% increase in operating expenses compared to a 56% increase in revenues, bringing operating losses over $30 million lower (~40%) even with a 2.7 pp increase in gross margin.

Vroom's realignment plan provides a quite detailed view into how the auto retailer aims to slash SG&A in a shift to EBITDA breakeven in the mid-term, to low single-digit EBITDA in the long-term.

While improvements in GPPU are likely to be stretched across multiple quarters to years, improvements in logistics and fixed costs are likely to show first improvement, as Vroom cuts headcount and works to increase regional distribution, avoiding high 3PL costs in delivery. GPPU targets under Vroom's goal can offer significant leverage should costs be controlled given that the target GPPU is more than double current GPPU.

Without digging too deep into the fine details of Vroom's realignment plan, enhancing GPPU while scaling back on marketing and fixed costs, and digitizing operations to minimize SG&A outline a clearer path to breakeven that Vroom has yet to distinctly show.

Will Q2 Show Positive Steps?

Vroom's Q2 report on Monday, August 8 marks the first critical test for Vroom's realignment plan, as shares have charted a course past $2 to the highest level since April on the backs of Carvana's ( CVNA ) optimism and potential short squeezing action. Will Vroom's Q2 show a vital boost to EBITDA and improvement in GPPU, or will Vroom fall short of targets with inbound transportation and retouching costs higher, which rival Carvana attributed to an ~27% decline in retail GPPU?

Normalization in the used car market suggests Vroom is likely to see a boost in sales as demand trends higher as used vehicle prices drop. Cox Automotive noted that retail " prices for used vehicles remain elevated, but June listing prices dipped to $28,012, compared with a revised $28,312 at the end of May. Price growth versus the year earlier was 28% in mid-April but has been falling since then and now stands 12% higher than a year ago." Cox also believes "further declines in retail listing prices should continue over the summer."

Declining prices should translate to increased used vehicle demand, especially as new vehicle supply remains pinched with OEMs such as Toyota ( TM ) cutting production output forecasts, with Cox seeing new vehicle sales falling nearly 12% in July. However, effects from inflation and affordability are potentially hitting the lower-income consumer cohort harder. Carvana reported a record volume of 117,564 vehicles, a nearly 8% q/q increase, reflecting a stronger demand environment for used vehicles.

Cox also forecast that "we could see weeks and months in the back half of 2022 where we see the industry sell more used vehicles than last year." With Carvana seeing strong demand and record volumes, there's two main takeaways for Vroom -- either industry-wide demand is strong and pushes unit sales above a guided ~10,000 to 12,000 run rate for Q2, or Carvana is taking a higher market share, preventing Vroom from seeing meaningful growth in Q2 and beyond as unit sales reset to prioritize unit economics.

For Vroom, it's likely a combination of both in play -- Carvana noted that its "growth in the [second] quarter reflected significant market share gains versus the used vehicle industry as a whole." However, Vroom's guidance of 18,000 to 19,000 vehicles is suggesting flat to negative sequential growth -- either Vroom is expecting to lose market share, or is projecting a weaker used car market. Signs at the moment point to a stronger-than-expected used car market, so maintaining market share should see Vroom top e-commerce unit guidance.

What Can See Q2 Be A Catalyst For Shares

Technically speaking, Vroom has advanced to a prior key support level at $2.33 with heavy volume, with the next upside legs looking to break the $3 range. Vroom's Q2 has the potential to chart a course higher, but there are a few important factors to watch for that can determine Vroom's fate. These include GPPU, progress in EBITDA, and liquidity, as the quarter will show the first view into the effects of the realignment plan.

• GPPU : Vroom showed significantly less of an impact to GPPU in Q1 than Carvana did -- Vroom saw just a 14% decline y/y in e-commerce GPPU, while Carvana noted a 22.5% y/y decline for retail GPPU in Q1 and a 34% y/y decline in Q2 . Carvana saw a substantial impact from inbound logistics and retouching costs in Q2, and while Vroom is likely to see similar impacts, its logistics network has the ability reach a high percentage of customers in under 100 miles (65%), and changes to a regional logistics structure are expected to cut logistics costs in half to under $600 in the long-run. With fuel surcharges and high fuel prices high throughout Q2, minimizing impacts to ~15-20%, compared to Carvana's 27% impact, can show that Vroom can successfully redesign to a local delivery scheme and cut costs in the long run. Decreasing fuel prices during Q3 could see upbeat GPPU figures in Q3 as well. Stronger demand and pricing power (an 8.5% y/y increase for Carvana) are likely to play a role in offsetting any possible GPPU declines from quicker days to sale and related transportation and retouching costs from a strained auto parts market -- as such, Vroom may be able to see a 4-6% sequential improvement in GPPU. Management noted that Vroom is "seeing very favorable early results from those changes that have been implemented," such as the resetting of unit sales to prioritize favorable unit economics, which will be shared in Q2.
• Progress in EBITDA : In the mid-term forecast, Vroom is aiming for breakeven in EBITDA, aided by UACC securitization. To reach EBITDA breakeven, Vroom is targeting a 30% reduction in SG&A and nearly a 100% increase in total GPPU, stemming from increased product GPPU and attachment rate. While this is unlikely to arise until late 2023/early 2024, Vroom is already underway with efforts to move towards breakeven. Lighter SG&A spend combined with improved GPPU could push Vroom's EBITDA to a three-quarter high, to ~($88 million), a $20 million improvement q/q offset slightly by the unit volume reduction. For the remainder of the year, Vroom's steps to minimize SG&A and increase GPPU could lead to minimal sequential improvements in EBITDA, to some ~($130 to $150 million) for H2; however, this implies strong pricing and less impacts from costs such as logistics. A second sequential in EBITDA will add confidence in Vroom's realignment plan and targets, especially if Vroom can show y/y improvement in EBITDA for the full year.
• Liquidity : Vroom is targeting approximately $500 million in liquidity by year-end, which comes out to an average cash burn rate of ~$33 million quarter. JP Morgan is seeing a potential cash burn rate of ~$400 million in 2023, which would drastically erode Vroom's current liquidity position. Improving EBITDA and generating cash flow from UACC to meet the high end of targets would see Vroom burn ~$40 million for the full-year, a substantial improvement that should further fuel confidence in the plan; however, Vroom likely will still need to tap into some outside financing sources in 2023 to further improve liquidity.

Vroom is facing a critical quarter, needing to show improvements in key indicators as it enacts its realignment plan -- Carvana's results indicate upside in guidance and pricing power pushing GPPU higher, while cost management can enable EBITDA to exceed estimates. Such a combination can serve as a catalyst to shares trading near bankruptcy levels.

Bankruptcy Fears

The biggest risk at the moment to Vroom is the fear and risk of bankruptcy, as shares currently reflect a higher degree of skepticism around the company's future. Improvements in liquidity and cash burn rate throughout the year and into 2023 can ease bankruptcy fears, but a weaker Q2 performance as unit volumes reset to focus on unit economics is likely to add fuel to the bankruptcy risk fire.

If Vroom sees higher transportation and logistics costs override any positive impacts from vehicle pricing in terms of GPPU, or fails to show improvement in net losses and EBITDA, it faces a slippery slope after talking up improvements in GPPU, cash burn rate, EBITDA, and other factors in Q1.

Playing in favor of a bankruptcy risk via options can minimize risk to a long position, but will not completely mitigate losses. For example, at $2.31 per share, the $2 strike puts for January 2023 will cost ~$0.65 per contract, taking total cost up to nearly $3 per lot, while providing downside protection of ~$1.3 per lot if Vroom goes bankrupt.

Outlook

Q2's earnings report kicks off what looks to be a high-risk, high reward play on Vroom -- signs of sequential improvement made under the realignment plan, including minimized cash burn, improved GPPU and EBITDA, and possible stronger-than-anticipated unit volumes can reignite confidence in management's focus on unit economics and profitability, and open the door for shares to retake $3.

On the other hand, Vroom's financial situation is still in a precarious position, and a higher-than-expected cash burn rate, or higher-than-expected losses due to the reset in unit volume and high transport costs are both likely to add more fuel to bankruptcy fears, which have been prevalent over the past few months.

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