In July 2021, Carvana stock peaked at $377. By November 4, 2022, shares had lost 98% of their value – falling to around $9. With 36.3% of the stock being sold short, many investors stand to gain if Carvana shares continue to fall — as low as $1, Morgan Stanley said.
As long as the meme crowd doesn’t rampage against Carvana short sellers, the case for a stock price decline remains compelling. These include
- Disappointing financial report for the third quarter
- Declining industrial demand
- Weaker cash position
- Lower profits from the sale of loans
- Bad credit
- Gloomy prognosis
Disappointing financial report for the third quarter
The worst thing a company can do during a quarterly conference call is fall short of expectations. Carvana certainly achieved that dubious distinction on Nov. 3 — falling short of “Wall Street’s sales and earnings expectations for the third quarter,” according to CNBC.
Here is the bad news litany:
- Revenue of $3.39 billion fell 2.7% — $320 million below estimates, according to Refinitiv.
- Carvana’s loss per share was higher than expected at $2.67 per share.
- Gross profit fell 31% to $359 million.
- Retail units sold fell 8% year-on-year to 102,570 vehicles
- Gross profit per unit fell over 24% to $3,500.
Consumers struggle to afford what Carvana sells. As CEO Ernie Garcia III told the Wall Street Journal, “Monthly payments for customers who buy a car now are about 160% higher than they were before the pandemic.” Due to higher interest rates, Carvana’s profits from selling customer auto loans are down external investors less.
Declining industrial demand
The pandemic has been great for used car dealers. In 2022, however, the fortunes of the industry reversed.
During the pandemic, supply of new vehicles has lagged far behind demand due to supply chain issues and semiconductor shortages. Consumers in need of vehicles opted for a used car or truck – driving up used car prices and profits.
The macroeconomic challenges of 2022 have changed consumer behavior towards used cars. In the face of high inflation, rising interest rates and fears of recession, consumers are less willing to pay record prices for used cars.
This drop in demand has hurt the industry. According to CNBC, the result was “declines in Carvana and CarMax” and warnings of slowing demand for used cars from “major new and used car franchises like Lithia Motors.”
Weaker cash position
Carvana was a veritable money incinerator. Between June and September 2022, cash on hand decreased by $734 million – leaving Carvana with just $316 million in cash.
Carvana tried to reassure investors by saying it “can borrow about $2 billion to buy cars and make loans and raise another $2 billion from real estate,” according to the Journal.
Seth Basham, an equities analyst at Wedbush Securities, predicts Carvana will need to raise more capital. If not, he estimates it “won’t be able to hold enough cash to meet its floorplan funding requirements (recently amended under more stringent conditions) to fund its business into 2023,” according to the Journal.
I think Carvana is overly optimistic about his ability to raise more money. As the Journal reported, Garcia said “that [Carvana] had $4.4 billion in liquidity, although only half of that is tied up. Much of the rest is based on assumptions that may not work out.”
Additionally, Garcia declined to comment on possible stock sales to reduce his debt burden. Instead, he told investors that Carvana could get the liquidity it needed by cutting costs. After a 12% headcount reduction, “there is no potential for huge savings” from another $656 million in operating cost cuts, the Journal noted
Carvana’s credit rating plummeted this spring. As I wrote in May, Moody’s downgraded Carvana’s corporate family rating to Caa1 at the end of April.
Moody’s had a number of reasons for the downgrade, such as:
- “Very weak credit metrics, continued lack of profitability and negative free cash flow generation,”
- “Governance considerations” – such as Carvana’s decision to update its “external floor plan facilities” despite expectations of significant negative free cash flow. and
- His decision to “finance the acquisition of [wholesale auction service] Despite its very high level of debt, ADESA is partially indebted.”
Moody’s said it may downgrade its ratings “if the company is unable to sustain positive operating earnings or if liquidity weakens for any reason.”
Carvana remained lively. As CEO Ernie Garcia told investors on April 20, “While this quarter may be a little harder to see than most quarters, we remain on track to build the largest, most profitable auto dealership and the way to go.” changing how people buy and sell cars. The march goes on.”
While Moody’s didn’t change its rating, Carvana’s Nov. 4 report prompted Morgan Stanley analyst Adam Jonas to “retire his rating on the auto dealership, saying its stock could be worth as little as a dollar,” according to Bloomberg.
This rating change is a big turnaround for Jonas, who had a $430 price target on the stock in early March. Jonas cited the deterioration in the used car market and a volatile financing environment for the switch.
CNBC reported that Jonas wrote: “While the company continues to pursue cost-cutting measures, we believe that a deterioration in the used car market combined with a volatile interest rate/financing environment (bonds are trading at a 20% yield) make the outlook significantly riskier, which is what contributes to a variety of outcomes (both positive and negative).”
Meanwhile, the bond market is lowering the value of Carvana’s bonds — indicating growing fears that the company’s ability to meet its obligations is weakening.
For example, Carvana’s 5.875% senior unsecured notes due 2028 fell to a record low of 36 cents on the dollar on Friday afternoon in New York,” according to Trace data.
Reduced profit from the sale of credit
In the past, Carvana made a large portion of its profits from the sale of loans that buyers took out to purchase its used vehicles. According to the FT, “Profits from the sale of loans, along with other ancillary fees, have typically accounted for more than half of Carvana’s gross profit per unit.”
Those gains have plummeted since their peak in 2021. Gross profit per unit from the sale of loans and other fees fell 23% from $2,500 to $1,921 in the third quarter of 2022, according to FT.
Carvana is not optimistic about 2023. Garcia described the next year as “a difficult year”. As he told investors last Thursday, “Cars are an expensive, voluntary, often funded purchase that has inflated much more than other commodities in the economy in recent years and is clearly affecting people’s purchasing decisions.”
Garcia called the end of the third quarter the “most priceless point ever” for customers financing a vehicle purchase. Although they are down 7% over the last year according to the Manheim auction house; in October, used car prices were still 43% higher than three years ago, according to the Journal.
With average used-car loan rates up 9.6% in October — the highest in about 10.5 years — the average monthly payment for a used vehicle in October rose 8% year-over-year to $564, according to Edmunds.
A short seller is pessimistic about Carvana’s future. According to FT, Spruce Point Capital Management founder Ben Axler said, “Carvana has not generated positive cash flow since it first reported financial data in 2014 — over eight years ago. Now that capital has become more expensive [it] will really test investors’ appetites to fund its loss-making business ventures.”
Carvana sees a bright future. “While progress is rarely linear, we remain on the path to becoming the largest and most profitable auto dealership,” Garcia told FT.