Vehicles sitting inside a Carvana vending machine in Westminster, Calif.

Patrick T. Fallon/Bloomberg

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Prices for used vehicles have shot 42% higher in a year, according to a new U.S. inflation report. Some drivers are rolling in unrealized gains. The Honda Odyssey, Kia Telluride, and Dodge Challenger are among more than a dozen models that recently fetched more used than new, thanks to manufacturing shortages.

Used-car dealers are delighted. They buy cars and mark them up for resale, which means they typically make money whether prices are high or low. But when prices rise this quickly, bumper profits are inevitable.

Take fast-growing

Carvana

(ticker: CVNA), which has a largely online model. Three years ago, its gross profit per vehicle was about $2,000. The long-term goal is over $4,000. Last quarter, the company blew past $5,000.

“Trying to figure out exactly how much of that $5,000 is attributable to this unique environment is not a simple thing to do,” says CEO Ernie Garcia III.

For now, the company is predicting gross profit of over $4,000 per vehicle for the year, suggesting that conditions will cool from here. They might, slowly.

Car production has been held up by a semiconductor shortage. The worst effects will hit this quarter, and the chip shortage could ease by late next year,

Intel

CEO Pat Gelsinger recently told me.

Garcia says investors should watch Carvana’s long-term trend of rising efficiency, which stems from structural advantages. Chief among those are its 50- to 100-acre inspection and reconditioning centers, or IRCs.

There, nine-car haulers pull in from the freeway, sometimes 10 to 15 of them at a time, to deliver the vehicles that Carvana has bought. Features and options are noted, and diagnostics performed. The vehicles are taken through a series of timed stations for routine work, or are pulled aside for more complex fixes. After a final spiffing up, cameras take 360-degree pictures for sales listings.

At a typical dealership, a highly skilled mechanic performs both simple and complex jobs on cars before resale. Carvana, with its assembly-line process, can bring on workers for simple tasks and gradually train them for more-skilled work. That keeps labor costs relatively low, Garcia says.

And whereas dealerships operate in choice retail locations, Carvana’s IRCs are set up in remote areas, saving on real estate.

Carvana added its 13th IRC near Cleveland in the last quarter, and says its capacity for turning around cars for resale held back sales. It has plans for eight more centers by the end of next year, which will bring its yearly production capacity to 1.25 million vehicles.

Last quarter, the company sold nearly 108,000 cars at retail, a 96% increase from a year ago. The percentage of cars that it sources from customers has been rising, and these come with higher profit margins than cars sourced from auctions.

Customers can get quotes on their cars online with their plate numbers. Carvana picks up trade-ins and delivers customer purchases, or buyers can collect their cars at one of its “vending machines.”

Those are robotic, multistory glass facilities that make a show out of fetching cars, complete with an oversize coin that customers can place in a slot.

“It has generated fun, memorable experiences for our customers and become part of our brand,” Garcia says.

Shareholders are enjoying the ride. Carvana went public in 2017 at $15 a share, and traded below that price at first. It has rocketed higher since then, including roughly quadrupling in price since just before the pandemic, to a recent $360.

Just over 60% of analysts who cover the stock say to buy it. Nearly all of the rest rate it at Hold, with many of them citing valuation as a concern. Carvana turned profitable on a net basis last quarter, but it isn’t expected to turn a full-year profit this year or next.

This year, Carvana is expected to more than double its revenue, to $11.7 billion. That puts it in a distant second place—for now—to

CarMax

(KMX), which has more than 220 stores, and whose revenue for its fiscal year ending February is estimated at $25.9 billion. But beyond this year’s wild ride, Wall Street expects Carvana to continue to grow revenue at rates north of 30%, versus mid-single-digit rates for CarMax. Some analysts see Carvana taking the lead on revenue within several years.

Garcia helped create Carvana in 2012 while working at DriveTime Automotive, formerly Ugly Duckling, which specialized in subprime buyers, and was founded by Garcia’s father, Ernest Garcia II. There is a checkered history; as an Arizona land developer, the father pleaded guilty to a count of bank fraud in 1990 for a small role in the savings-and-loan crisis of the 1980s. And DriveTime was fined by regulators in 2014 for collection practices.

Today, DriveTime and Carvana, both based in Tempe, Ariz., are run separately by the two men, but maintain business relationships that, as Carvana’s annual report puts it, were “not negotiated at arm’s length.”

The younger Garcia’s challenge will be to continue building Carvana’s image as the

Amazon.com

of the used car trade, while steering clear of the industry’s less-pleasant practices. Carvana provides its own financing, and says credit performance has been strong, but also that it sells loans off after making them.

How big can Carvana become? CEO Garcia says “two million plus” vehicles a year. The two million, he says, comes from extrapolating current trends. The plus comes from the fact that the U.S. used-car industry is fragmented and huge, with 40 million vehicles sold a year.

“When you’re building a business, and especially early on,” he says, “it’s hard to project what the dream might finally end up being.”

Write to Jack Hough at jack.hough@barrons.com. Follow him on Twitter and subscribe to his Barron’s Streetwise podcast.

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