Why in the World Is Carvana Buying Brick-and-Mortar Dealerships?!

Carvana (NYSE: CVNA) spent years convincing consumers and investors that the automotive industry was ripe for disruption through e-commerce. Many weren't believers in the vision and believed consumers would always prefer in-person visits and test drives.

But Carvana proved e-commerce could be powerful in the automotive world. Over recent years, a $10,000 investment would have turned into over $420,000. Rather than take a victory lap to taunt its rivals, Carvana is doing the opposite, and buying dealerships -- from Stellantis (NYSE: STLA), a struggling company, of all automakers. What in the world is Carvana thinking?

Image source: Getty Images.

What's going on?

It seems a bit strange for Carvana to go all-in on its online platform to drive its used-car retail business to new heights, only to then go backwards and scoop up a handful of Stellantis dealerships. But there are interesting points some investors may not have considered.

Carvana recently purchased its sixth Stellantis dealership, slightly altering its former all e-commerce approach. At first glance, investors might assume that scooping up dealerships is simply to diversify and expand sales from used cars into a hybrid of new and used cars, with new car sales representing better margins. This is partly true, and we'll dive more into this in a moment, but let's use AutoNation (NYSE: AN), a leading dealership group, as an example to better understand the auto retail business.

Data source: AutoNation 10k filings. Table source: Author.

This is a simple, yet phenomenal, example of what exactly Carvana is gaining. Yes, adding dealerships opens the door to incremental profits from the new car route, but as you can see that only adds a little value compared to the used car business. Parts and service is the game changer for the dealership business, and now Carvana is dipping its toes into that higher-margin business.

This also widens Carvana's funnel for gaining inventory at favorable pricing. It's generally true that trade-ins, or Carvana buying your car, is more valuable to the company than gaining inventory from auction sites. As Carvana is continuing to accelerate its used car business nationally, its competitive advantages are amplified by having more inventory -- or more favorably priced inventory.

How Carvana wins

The automotive retail industry is highly fragmented and while Carvana is the nation's second-largest used car retailer, its market share is currently around 1.6%. Carvana recognizes the value in owning dealerships for parts and services revenue and higher margins, among other benefits such as access to used-car trade ins. At the same time, car dealerships recognize the value in a national distribution, pricing system, and online convenience. This will force massive industry consolidation.

Carvana has already accomplished the difficult task -- it's easier for Carvana to buy dealerships and gain advantages than it is for a small fragmented dealership group to create artificial intelligence-driven pricing and appraisals, national distribution networks, and a competitive online presence. As the industry speeds toward massive consolidation, savvy investors would be wise to put capital into companies such as Carvana.

Daniel Miller has no position in any of the stocks mentioned. The Motley Fool recommends Stellantis. The Motley Fool has a disclosure policy.