Vroom's Detour: Rapid Expansion Outpaces Profits

Vroom Inc. VRM is an end-to-end e-commerce platform in the used vehicle industry, offering convenience for consumers to buy and sell used cars online. Through its scalable, data-driven technology, the company provides an extensive selection of used vehicles, transparent pricing, competitive financing and convenient at-home pickup and delivery.

Competitive edge

The company's innovative e-commerce model for buying and selling used cars online provides clear consumer benefits like selection, transparency and delivery convenience. As an online used car dealer, Vroom faces competition from companies like Carvana Co. CVNA, Shift Technologies Inc. SSFT and traditional dealers, but has carved out advantages in key areas like pricing, customer service and nationwide inventory to stand out.

Specifically, Vroom is able to leverage its efficient online model and low overhead to offer competitive pricing compared to first mover Carvana, which has greater brand awareness and scale. Its customer support and white-glove delivery service also aims to differentiate from Carvana post-purchase.

Additionally, the company ships nationwide, unlike smaller regional players like Shift Technologies, and provides a more transparent and convenient experience than traditional dealers. By focusing on value, service and selection, Vroom has developed a strong position in the emerging online used car market.

Rapid growth outpacing profitability and operational efficiency

Vroom has seen rapid revenue growth in recent years, fueled in part by changing consumer preferences during the Covid-19 pandemic. The company's revenue rose from $855 million in 2018 to $3.2 billion in 2021 as more people chose to shop for vehicles online. However, its operating losses have also mounted quickly over this period, increasing from $80 million in 2018 to over $350 million in 2021. The company's fast pace of growth has outpaced its ability to reach profitability, leading to widening losses even as revenue continues to expand.

VRM Data by GuruFocus

Likewise, negative free cash flow has ballooned from $67 million to nearly $600 million as the company's breakneck expansion results in spiraling costs. Thin gross margins around 5% to 7% reflect ongoing challenges with reconditioning and logistics as a low-cost operator at scale. As Vroom expands, containing variable costs per unit becomes more difficult.

Moreover, with the used car market highly competitive, selling, marketing and compensation comprise a substantial portion of Vroom's surging overhead costs. Selling, general and administrative cost jumped from 15% to 18% of revenue between 2018 and 2021 to over 28% in 2022.

While improved 2022 margins are encouraging, Vroom has fundamental work ahead to refine unit economics and achieve cost leverage. The rapid increase in losses and cash burn signal execution risks on its growth roadmap.

Investor considerations

Vroom's innovative e-commerce business model and prospects for future expansion may appeal to growth-oriented investors. However, the company's lack of profitability and high cash burn should give investors pause. The business model requires major fine-tuning before economies of scale kick in. Until operational efficiency improves, the company's losses and cash burn will likely persist.

Signs of progress amid long road to profitability

The company's latest earnings release contained several positive signs that the online used car retailer's transformation efforts are gaining traction, even as profitability remains elusive. The 13% sequential improvement in adjusted Ebitda loss to $56.3 million indicates the business is heading in the right direction. Vroom also posted its first quarterly increase in e-commerce units since the second quarter of 2022, rising 5% amid a pivot toward responsible growth.

Gross profit per unit jumped 16% sequentially to $2,954 thanks to margins above $5,000 on aged vehicles. This provides a blueprint for Vroom to boost profitability as it sells through its remaining aged inventory in upcoming quarters. Reduced SG&A expenses and convertible debt buybacks at a discount further point to an improved cost structure and balance sheet. These are necessary steps before the company can realistically target profitability. But the $200 million to $225 million Ebitda loss guidance for 2023 makes it clear Vroom still faces a long road ahead. Investors may welcome the progress, but will want to see further sequential improvements in unit economics.

Heavy reliance on external debt financing

A major concern for Vroom is its heavy dependence on debt financing to fund operations and growth. As of June, the company had nearly $542 million in short-term debt and $545 million in long-term debt, compared to only $245 million in cash holdings. With the company estimating it will generate negative Ebitda between $200 million and $225 million, its high cash burn rate and debt load raise questions about the sustainability of its growth trajectory without further external financing. Given its lack of profitability, Vroom appears reliant on raising additional capital through debt issuance or other means to achieve projected revenue growth. This reliance on continual new financing, rather than self-generated cash flows, represents a precarious and unsustainable capital structure in the long run. Vroom will need to demonstrate a path to profitability and positive cash flow to shift toward more stable financial footing.

Potential 13% upside in two years if estimated growth is achieved

With expected revenue growth of 27% in 2024, reaching $1.18 billion, Vroom is projected to expand at a faster rate than competitors Carvana (13.15% growth) and Shift Technologies (7.85% growth). Given the company's superior growth outlook compared to these peers, its valuation of 1.07 times sales does not appear overly expensive. While Carvana trades at a similar sales multiple, the slower-growing Shift Technologies has a lower 0.6 times valuation.

Considering Vroom's industry-leading growth, its current valuation seems reasonable compared to other online used car retailers. The company's rapid expansion helps justify a higher valuation multiple than slower-growing Shift Technologies, and one on par with Carvana's despite Vroom's faster growth profile.

If Vroom can reach $1.18 billion in revenue by 2024, a simple 1 times revenue valuation could make its enterprise value worth $1.18 billion, only 13% upside from the current trading price.

Key takeaway

In conclusion, while Vroom is growing revenue rapidly, the company's lack of profitability and heavy reliance on external financing to fuel expansion undermine the sustainability of its business model. Absent a clear path to self-funded growth, Vroom's precarious capital structure, loaded with debt, leaves little margin for error. Even if the company achieves its 2024 revenue target, the potential upside based on a 1 times sales multiple is only 13% from current levels.

Given the execution risks and limited reward, Vroom may not be worth the risk for conservative investors at this juncture. Unless the company can demonstrate it can turn profitable and generate positive cash flows at scale, its growth trajectory will remain on unstable footing. Until operational efficiency catches up with top-line expansion, the stock does not appear attractive now.