J.P. Morgan Automotive Conference

Aug 11, 2021

Good morning, good afternoon, and good evening, everyone. Thanks a lot for joining the webcast. My name is Rajat Gupta, member of the US automotive equity research team at JPMorgan. Very pleased to have with us Alex Wetter, CEO of cars.com. On the format of today's discussion, Alex will be starting off with a couple minutes of prepared remarks about the company, after which we will dive into q and a. If anyone in the audience does have a question, please feel free to post it on the conference portal, and I can ask it anonymously on your behalf. Or you could also email the question to me or anyone from my team, and we'll make sure to ask the question. Well, with that, thanks, Alex, and, I would like to hand it over to you. Thanks for having me, and and thanks for everybody tuning in today. Certainly, I think of all the industries that we could be talking about, automotive has got a lot of exciting things happening in it. This is the best retail environment that we've seen in over a decade, and COVID has accelerated rapidly the industry's adoption towards digital platforms. I think I hope everybody here knows the name cars.com. We're the leading brand in the online automotive space. It's been tried and tested over twenty years. But I think what's important about this opportunity is is our stock hasn't fully appreciated the enormous transformation that's happened in the business over the last few years. We were a legacy company trapped inside media companies, and we were able to break the company out of its legacy ownership and and spin it out into a new form. And the transformation has largely been successful across all the the various pieces that we've changed. We've made strategic acquisitions that are now growing at fast double digit rates, and our car core marketplace is now the fastest growing in the category. And so, we're really excited primarily also because our our strategy is differentiated. We've made a deliberate shift towards being an enabler for the auto industry. Our digital solution strategy is rapidly growing both with OEMs and with dealerships, And we've made some major migrations in our technology towards the cloud that's accelerating the pace of innovation. You probably see this in our in our growth in both customer count and in pricing despite some pretty surreal trends in the broader industry. So happy to be here, Rajat, and just we'll we'll turn it over to you to guide this conversation. Great. Thanks. Thanks for that intro. I just wanted to start off with, you know, more like consumer centric question. You know, give given your platform is consumer centric, you seem to have great visibility on underlying demand trends. Could you could you give us an update on just the general health of consumer demand, you know, dealer inventory levels, maybe in context of levels you've seen in the second quarter and first quarter, and also in context of the record pricing we have seen recently, and if that is starting to have any impact. You know, General Motors made a comment on one of their earnings calls recently that they wanna be careful with pricing and, you know, there's like an upper limit ultimately and how how high it could go. So so any thoughts on that to start off, would be would be super helpful. Well, a couple opening comments and we can dig deeper on any one of them. You know? So inventory shortages are are real, but they do vary by market and by manufacturer. And I think this is one of the reasons why our platform has stood up so well during this this, this supply crunch in that know, platforms like cars break down geographic and physical barriers. If you're looking for a specific car, you can search nationwide and find who has the car you're looking for. And so I know both manufacturers and dealers are realizing that even if they have lower inventories, they still need to have their inventory that they've got to be found. We are seeing differences between domestic and imports. So, you know, Ford has been well documented. It's been extremely impacted by the production challenges. The f series trucks have been the number one selling vehicle every month since before 02/2011, but now is number three in May and June and has felt some of the largest declines largely due to inventory shortages. But the consumer demand is persistent and is outpacing supply. So if you look at our platform, which is a pretty good summation of what's happening out there, new car inventory levels are down about 35% on our platform in q one, and now it's down close to 65% as we're entering in this, you know, the the the tail end of the year. And used car inventories are also down almost 20% in or 20% in q one. We're seeing that slow down in in, only down about 12% in the recent period. But the consumer story is real. Right? Our our demand and our consumer traffic is up almost 10%. And I think underlying that to the health of the market, prices for inventory are actually rising. New car prices are up 17% since start of the year, and used car prices reached the high watermark of up almost 30%. So what this is leading to is record profitability. You're seeing this in all the publics. They're reporting it across the industry, and and gross profit per vehicle up substantially. I know Carvana reported their first quarterly profit, and and so the industry is in a really healthy spot right now. Got it. So it doesn't seem like pricing is having, any pricing has not gotten to a level where it's starting to really sway customers away, in terms of, like, just, you know, in terms of just demand, and it just seems to be pretty healthy despite that. Is that fair? I I do think you're gonna see some used car pricing softening. I mean, one of the big trends, obviously, over the last year is the rental car companies. If if any of you have traveled recently, you know what I'm talking about. They haven't had any supply. They've been buying used cars, trying to replenish fleets that they liquidated this time last year. So I think with schools opening back up and and families going back to school, you're gonna see less travel. And so the rental car companies are gonna pull back in their buying patterns, is naturally gonna soften the used car market. That's just my own personal prediction, but I think we'll see some softening of that. But I think the consumer demand due to COVID is real in terms of, consumers wanna have the latest and greatest technology in their in their garage. They wanna have safe, reliable transportation. Got it. Got it. That's that's that's really helpful anecdote. I I I wanted to switch gears, you know, quickly to, you know, online digital retailing. You you as you've seen, as you've heard, you know, dealers are increasingly expanding, you know, their solutions, their own platforms, you know, just as consumers' appetite for online purchases, you know, have grown, you know, through the pandemic. Any metrics you could provide on, you know, the penetration or adoption of your digital solutions? And just kind of, like, what do you have in terms of, you know, offering pipeline or product pipeline that can further enhance this and make it easier for both the consumer and the dealer to, you know, transact, you know, through through your through your channel? Yeah. Well, look, I think, couple answers here. Number one, this industry shift towards digital channel experiences, we've led it with our acquisition of Dealer Inspire. Dealer Inspire had less than a thousand dealers when we bought the business. We we're reaching close to 5,000 dealerships where we're powering their primary website, including the ecommerce experiences for some of the largest publicly traded groups. So we're helping make the industry shift towards this digital first platform. I like to say our strategies like, we're really about arming the rebels. Right? We're giving them the tools and technologies so that they can complete, compete locally. I think, what's really exciting about our other business, our marketplace business, is that we're really about pretail versus retail, meaning that every consumer does heavy amounts of online research prior to purchase. And if you think about our platform, we've got 25,000,000 people actively searching for the car and the dealership they wanna do business with prior to launching into a retail transaction experience. And so our marketplace aggregates demand. Our solution strategy helps dealers convert that. And what we see in the data to me is very exciting with terms of our future prospect. I mean, we we've got decent SaaS like revenue with our subscription model, charging dealers around $2,000 and change per month. But now that we can see vividly our the transition of users from our marketplace into our digital solutions, what we're seeing in the data is that cars.com shoppers are converting at twice the rate of all of their traffic sources combined. And and most of our our marketplace is valued on lead gen, which is first generation advertising. I think second generation and third generation where we're going is really helping get that consumer journey from a market wide view into a digital experience and helping dealers convert that traffic to sales. I think this is why all the big publicly traded groups list their cars on cars.com. They see this being digital only. They know how well our traffic converts, and now we've gotta convert the long tail of the industry to see what the big guys do. Got it. And just to follow-up on that, you know, TrueCar talked about this, you know, they're piloting this end to end solution where consumers can do, like, an end to end transaction through them. And, clearly, like, it seems like that's what consumers are looking at in terms of, like, experience. You know, Kavana provides, an end to end experience, and, you know, there have been a lot of talk about Carvana listing third party inventory and helping and providing an end to end transaction for that car, which is located at another dealer. How are what's what's your what are your initiatives on that front? Like, do we see you going towards that kind of, like, an end to end solution for the consumer and just to provide that kind of experience, you know, integrating the financing, the delivery, you know, the trade in, like, just managing that for the dealer. Is that, like, a path you think you or is that, like, how the industry models may look like in terms of your your participation in the supply chain? Okay. There there is a lot to unpack there. Let me try to break it down on some pieces. First of all, I think the word, you know, ecommerce and automotive is is overblown. I mean, at the end of the day, this is one of the largest physical goods that has to be delivered or picked up. And so it's not like it's gonna arrive in a in a brown Amazon box at your door. I think what I'm excited about is how many dealers are now offering home delivery. So we were we're the first to launch this nationally. We've got over 10,000 dealers now that are willing to drive a car to bring it to your home for a both a test drive or as part of a purchase. Dealerships are ramping up their BDCs, which their business development centers to to handle online transactions just like Carvana. And so the entire industry is starting to claim, high ground in terms of this new online experience. And and we're excited because we're helping the industry adopt it. I think, again, what's exciting about this is all these players trying to fight for transactions, the best way they can do that is to source shoppers who are in the research funnel and phase of the game, and that's where we aggregate demand. And so, you know, average user on our platform is spending a significant amount of time north of forty minutes prior to launching into a retail environment. And so as we aggregate demand, that's how we've got 19,000 dealers and growing plugging into our system. So I think our business is well positioned to help the industry shift, and we haven't even seen the OEMs who are now ramping up their omnichannel experiences as well, and we're excited about what that can mean for our business as well. Got it. Just one last point on, like, the online solution. You know, we've seen these acquisitions from, you know, like, just all of a sudden, like, last three or four months. We've seen, you know, like, Roadster get acquired by CDK, know, Gooba Goo by Reynolds and Reynolds. I mean, I don't know if I mix that up, but the, you know, the Darwin and, you know, they're they're I've been hearing about Autofy. So just curious as to, like, why why is this happening now? What's what's the what's the power of these acquisitions? Like, how does that help the industry accelerate towards ecommerce? And and and where and where do you fit within within this within this landscape then? Well, look, I think, as I said in the opening, I think what COVID has done is it's made the entire industry, radically shift their strategy towards technologies and digital solutions, which which has been our strategy all along, and and that's why you're seeing acceleration in both dealer count and average revenue per dealer. And we see that those trends continuing to scale. I think, this is a big TAM opportunity, so there's no shortage of of new technologies and tools to compete. I think we're excited about the opportunity to plug in tech new technologies into our existing distribution. I mean, it's a highly fragmented industry. There aren't many platforms that aggregate both consumer demand or dealer participation. We're one of the leaders in both. And so as we look at our capital allocation, it's easy for us to identify technologies that the industry wants and plug it into our existing distribution. I think you're seeing this with fuel, which is our our digital video platform. You know, we know that you don't need a television station anymore to broadcast. Digital channels have taken over the airwaves, yet dealers and the auto industry are spending 10,000,000,000 in linear TV, broadcasting to the mass market. What was fuel? We actually allow the industry to narrow cast just to the percentage of the population that's in market, And it's the fastest growing product in our set because we've already got distribution built with dealers. We've already got strong consumer demand. We've built fuel and distributed it, and I think you're gonna see more opportunities like that from us in the future as we put our capital to work. Got it. Got it. That's that's helpful color. Any just to follow-up on one of your previous comments, you know, where you ended by talking about the OEMs moving to omnichannel. You know, Ford talked about their order bank model, you know, on their earnings call recently, you know, and as dealers carry significantly lower inventory, you know, this talk about, like, this agency model that might come into play in The US, you know, similar to, like, what we have heard in Europe. So what what do you think is gonna be the new normal for the industry structure going forward as these OEMs start to, you know, deploy this reservation system? Like, how how how is the dealer relationship gonna look like, and and how do you what kind of role do you see yourselves playing there? Well, look, I think the nonnegotiable, durable trend in the auto industry is is research prior to purchase. Next to buying a home, this is the the second biggest ticket item in in everybody's lives to buy. So to think that you're gonna build one ecommerce experience and everybody's just gonna go there and buy without doing any research, you know, that's a fool's errand. I mean, we've been around for twenty years and yet have no problem or, you know, aggregating 25,000,000 car shoppers every month. 75% of our traffic is coming to us organically or directly. We don't have to spend ungodly amounts of SEM to build our traffic. It's coming to us naturally and organically. And if you look at what happened in COVID, even we cut our marketing budget in half, our traffic numbers surged because this is the, you know, the better consumer experience. You don't wanna buy a car going through one channel. You wanna see a market wide view, and that's what we've always been. I think as the funnel gets smarter digitally, OEMs and dealers are seeing what I've known all along is that that research, traffic converts at the fastest and best rate. You know, they're hand raisers that are actively in the market. And so I'm thrilled that the OEMs are now studying Google Analytics better. I'm thrilled that dealers are hiring people to help them analyze these traffic trends. What we see vividly through our Dealer Inspire back end of 5,000 websites is that cars.com traffic converts higher and generates more volume than all our peers. And so I I think that we've got a very durable marketplace business. Marketplaces, tend to be the dominant, use case for for mass market users. I think that's why you're seeing dealer participation. I think our solution strategy helps the vast majority of our industry advance towards digital retail. We've got all the tools to do that. And so I think our business is is well positioned to both ride the growth in digital spending and ride the growth in solution spending that everybody's gonna be adopting over these next few years. Got it. Great. You know, one thing we have seen over the last quarter, particularly in the second quarter, you know, relative to the first quarter and maybe pre pandemic, that dealers are becoming increasingly focused on retail sourcing, like sourcing cars directly from consumers. You know, just it it makes sense. Higher margins, less wholesale fees, and wholesale pricing itself has been so volatile. So on this front, you know, one of your peers recently launched an online appraisal tool helping dealers ramp up customer sourcing, you know, why instant transactions. So could you could you share your views on this pivot towards consumer sourcing? And how are you participating in that? How are you helping dealers? Could we see you launch, a major offering in that in that direction? Maybe you're already doing so, and it's probably not well appreciated yet. You know, any any any thoughts on that would be helpful. Yeah. Well, look. You've seen this in all the categories. I I know you cover a lot of different industries, and I think there there's a consistent trend, which is technology can destroy structure. And I think our industry structure has is ripe for disruption in that, you know, the legacy model of of using these giant third party intermediaries to source inventory has been the the legacy norm. But if you think about it, the dealer network is a structure unto itself, and dealers have shown that both the desire and a propensity to work together as a flexible network using technology to accelerate inventory turn. And if you think about our platform, we we already have 19,000 dealers working with us. It isn't hard to imagine us being able to add a technology layer that facilitates dealer to dealer trading that's tied to consumer demand. And so, you know, our digital solution strategy is an enabler. Like, this is our DNA. We are arming the rebels here to to do things more cost effectively using tech. I think what's also exciting is that without any effort, we've got 20,000 private sellers coming to cars.com each and every month, looking to sell their car. It's not hard to imagine, you know, how valuable that is. Every dealer will tell you they would prefer to buy cars direct from the public as opposed to competing in the in the auction lanes. And so we have organic assets that we've yet to monetize, and I think you can imagine, you know, simple technology solutions that would facilitate dealer to dealer trading, leveraging our strong organic, you know, private seller consumer model to enable the dealer network, it can be a massive growth opportunity for the business. Got it. That that's helpful. You know, as you know, some of the some of the dealership groups have launched their own, you know, nationwide brands, and some early results show that, you know, they're seeing pretty good penetration and good conversion. There's also a growing brand awareness, you know, and penetration of, you know, the digital news retailers like Arvana, Room Shift, etcetera. So in such a landscape, you know, when all these dealers are just doing it themselves, like, and spending advertising on their own platform, you know, what what what are the competitive advantages of cars.com that could help potentially retain, you know, a lot of these dealers despite them moving to their own platforms and their own brands? Well, look, I think the objectivity is number one. I mean, most consumers prior to purchase wanna wanna have a a trusted independent view of the market and and just look at inventory levels. I mean, on average last year, I think cars.com had 4,000,000 listings on our platform. You compare that to any individual dealership, even the largest publicly traded, they've got 40,000, 50,000 listings. That there's no comparison when you talk about getting a market wide view. This is why marketplaces, are dominant platforms all over the globe. I think the other thing is that independent curation. You're never gonna have, you know, consumers trusting first party sellers as much as they'll trust independent objective platforms. We let users curate the market. They users are free to write reviews, help us with pricing transparency. We're able to use technology to help educate the demand and supply side here. So I just think the the the use case of a a marketplace is typically 10 x that of any individual seller. Got it. Got it. That's that's helpful, context there. Could you give investors, you know, a bit of a recap of, know, on the dynamics of a Ford Direct partnership? You know, just what the related market opportunity is, you know, the cadence of the rollout, you know, I just realized initial, like, dealer traction that you might be seeing with that. Yeah. I think what you're specifically referring to there is, you know, first of all, it's great to see the car companies start to allocate capital towards digital platforms. Historically, OEMs earmark a lot of capital for new coffee machines, marble floors, fancier buildings. And I think what we're gonna see over these next few years is is OEM capital allocation towards digital technologies to help their dealer networks become more, you know, digital first. We've been a leader in that for a while now. We're we're shifting dealers towards digital platforms rapidly. I think you're you're seeing that when we won the GM business, which has been a rapid acceleration of GM dealers. And then you're also seeing that with our recent announcement with Ford. Ford, you know, again, has close to 4,000 dealers. You know, we're helping move them towards our our dealer inspire platform, and we're gonna continue to take share there. I think what's exciting about that is dealers can can now use our technologies to help them accelerate the shift towards digital channels, and and it's gonna be a strong growth, you know, model for us for for years to come. Got it. Got it. And on dealer rater, you know, I I know we we chatted about this, like, a month or so ago. You know, total reviews tracking ahead of 10,000,000. Like, what other what what other kind of similar, like, product enhancements or, like, just different adjacencies that you have in the pipeline that you could touch upon, you know, which is being more built organically by the business? Or or maybe there's some inorganic opportunities there that that you could that you could talk about. Well, look, I'm really proud of the innovation track at Cars. Not only did we just make a migration to a cloud based infrastructure that's gonna that has accelerated our pace of innovation, but look at what we built with fuel. We were the first to market with fuel. We're disrupting the $10,000,000,000 linear TV market. We see rapid adoption. When dealers plug into fuel, their market share grows. And and we're we're very early innings here of fuel. Fuel, by the way, retail prices for that are almost five x what our marketplace subscription is, and the dealers fuel, you know, aren't aren't giving it up. So so we see fantastic adoption there, and that's all been innovated in house. I think as I look out further in the horizon, two areas of of interest, obviously, are are online financing. You're seeing aggressive moves in in, lenders, both traditional ones and even new disruptive ones wanting to get closer to auto transactions. We think we can deliver a model to our consumer and dealer networks that's complementary and doesn't compete, but adds significant SaaS like revenue and and and online finance revenue to our platform. We talked about vehicle acquisition. We've got 20,000 private sellers organically coming to cars. We know the the auto industry would like to buy those cars directly from us. So those are probably the two biggest near field opportunities to expand our TAM and and to create new lines of growth. Got it. Got it. You may have already touched upon this a little bit in your previous on on the previous sourcing question, but I'm getting a question from an investor on, like, just exploring the wholesale marketplace more directly. You know, just f do the efforts of a company like ACV Auctions suggest there might be a role for you in the dealer to dealer wholesale volumes, you know, as dealer to dealer wholesale volumes might be increasing? Yeah. Sure. I mean, I think, again, dealers are wanting to do things more with tech versus less. If you look at what's happening in in the wholesale industry, the wholesale and retail channels are are blurring aggressively because pricing deltas between wholesale and retail is being replaced by velocity. And if you look at what you need to to compete in dealer to dealer trading, you need predictive visibility on retail demand. I can see things well before the auto industry can. I'm seeing the softening on used car prices in real time on our platform. And so we can help the industry be smarter about when to buy and at what price point. And and, dealers are already using our tools each and every day. We've got over 19,000 that are actively engaging in our tech each and every day. It's not hard for us to to direct our consumer sellers directly into our platforms so that dealers can bid on those cards and buy them directly. I think there's a lot of disruption and opportunities here for us. Got it. Great. Great. Thanks for thanks for clarifying that. You know, we have a couple of minutes left. I definitely wanted to touch on the balance sheet. Now your your net leverage position continues to get better. Now just curious as to, you know, what's what's next in terms of capital allocation, You know, what your priorities are? Are you considering, like, some strategic m and a, you know, pay down debt? This what what are the top like, maybe you can in rank order, like, what the priorities are, you know, for for capital allocation? Well well, number one, first of the business has proven to be highly resilient. And and and not only resilient, but somewhat insulated regardless of macro terms. I mean, I remember in o nine when the auto industry went backwards 30%, we grew our revenues 4% that year. Fast forward to COVID, If you look back at our financials, we outperformed all our competitive set and weathered that storm perfectly well. And now what you're seeing the business continue to grow despite pretty sensational supply chain disruptions. So first and foremost, we feel really good about the overall health and stability and strength of our business. You've seen us been paying down our debt. You know, we did do some strategic acquisitions like Dealer Inspire that are that are accelerating growth, and we've been paying down that debt from over four times leverage. Now we're down getting closer to two. So we're gonna continue to do that. But I also think, you know, there's an opportunity for the industry shift towards technology. And so there are bolt on acquisitions that we think are strategic just like DI that that can give us great technology that needs distribution. And, you know, if we're successful like we have been with Dealer Inspire, that can generate some significant growth and opportunity for our platform. As you'll see, Rajat, you know, we're generating significant cash flow today. Our our Right. Our cash flow yield, we're trading at about 15 times free cash flow. So so the business is super strong. It it it generates a ton of cash, and it's got the hardest things in the auto industry or distribution, both consumer and dealer. And we've got pretty strong pipes into both those markets, and and I think that we're we're in a good position as the industry shifts towards digital. Got it. Yeah. I think that's, that's a great way to end. So, thanks, Alex, for for joining us today, for these thirty minutes, and, you know, thanks everyone for listening in. Talk to you later. Thank you, Rajat. Have a great day. You too.