Online car dealer Vroom (NASDAQ:VRM) was one of the first initial public offerings to arrive as equity markets returned to normal. It has been a winner: Vroom stock has better than tripled from its IPO price.
The rally makes some sense. The novel coronavirus pandemic is leading many Americans to leave urban environments. Public transit looks far more risky. And so demand for used cars should increase — adding to Vroom’s growth potential.
Certainly, we’ve seen similar stories play out across tech, and across the market, over the past few months. Pandemic “winners” aren’t limited to just Covid-19 vaccine developers and the manufacturers of personal protective equipment..
The catch with those stories, however, is that the results have to back them up. And in the case of Vroom, this month’s second-quarter earnings report doesn’t look strong enough, particularly with Vroom stock up over 200% in a matter of months.
As far as the second quarter goes, the news doesn’t look that bad. E-commerce units sold rose 74% year-over-year. (Vroom has a single dealership in Texas, which is expected to become a steadily smaller part of the business over time.) Adjusted net loss of 34 cents per share was much better than consensus expectations of -70 cents.
The headline problem comes in terms of Vroom’s outlook for the third quarter. The company is projecting total revenue of $268 million to $290 million. Wall Street was looking for $345 million.
That’s a huge miss. And it’s likely the key factor in a steep sell-off in Vroom stock, which dropped 18% the following day.
But it’s how Vroom is getting to the guidance that appears to be a key reason for concern. The company is expecting sharply lower pricing. The Q3 outlook projects average revenue per unit of $23,500. As an analyst noted on the earnings call, that figure is down sharply from $29,000-plus as recently as the first quarter.
And that could be a problem.
A Pandemic Winner?
Again, part of the reason why Vroom stock has performed so well is that it should be a beneficiary of this pandemic. Online retailers across the board have seen their share prices soar. E-commerce growth should benefit Vroom as well.
But if the incremental demand is coming from lower-priced vehicles, the story gets a lot less interesting. Obviously, lower prices impact revenue. In fact, Q3 guidance suggests revenue growth of just 3%-11% year-over-year. Even assuming Vroom is guiding conservatively, that’s obviously not good enough.
There are also gross profit concerns. Average gross profit per unit in e-commerce is expected to come in between $1,600 and $1,700. That’s not much better than the $1,577 achieved in the third quarter of last year.
The problem is that GPPU was weak last year as well. As Vroom noted in its Form S-1 filed with the U.S. Securities and Exchange Commission, efforts to prioritize unit growth pressured the metric in last year’s second half.
Now, with (supposedly) a tailwind behind the business, Vroom isn’t able to improve profitability all that much relative to the pre-pandemic environment.
Between revenue and profit, Q2 actuals and Q3 guidance both lead to the conclusion that the current crisis isn’t as big a boost to Vroom as investors believed. Given the huge IPO pop and continued growth from that point into earnings, the sell-off makes some sense.
Vroom Stock Rebounds
Of course, Vroom stock has recovered more than two-thirds of the post-earnings decline. To be honest, I’m not sure why.
It could be that investors simply are taking the long view. That would make sense: I’ve been recommending that investors do precisely that since the worst of the March sell-off. And it’s possible investors see the long-term growth story here as reasonably intact, with Q3 just a sign of growing pains.
That could be true. But, again, Vroom stock trades at more than three times its IPO price. It’s valued at more than six times revenue.
Heading into earnings, VRM perhaps wasn’t quite priced for perfection — but it was close. At the least, investors were anticipating a significant long-term tailwind from the short-term environment.
At the very least, Q2 and Q3 suggest that tailwind isn’t nearly as significant as investors hoped. And after this rally and at this valuation, that seems like an awfully big problem. Investors buying this dip should be careful.
Matthew McCall left Wall Street to actually help investors — by getting them into the world’s biggest, most revolutionary trends BEFORE anyone else. Click here to see what Matt has up his sleeve now. As of this writing, Matt did not hold a position in any of the aforementioned securities.