The central theses
- Used-car market Carvana saw its shares plummet 48% in two days after miserable third-quarter earnings
- Carvana stock is down nearly 97% year-to-date (YTD) as an overheated auto market is finally showing signs of cooling
- While lower auto prices are good for consumers, investors could suffer a setback if automakers’ profits and forecasts fall
Carvana stock took a massive nosedive on Friday as investors fled the coupe. The online car retailer’s share price fell 39% in one day, while trading volume hit an all-time company record of 71 million.
After another 18% drop in premarket trading on Monday, the tumultuous first-week session was riddled with trading disruptions. Carvana shares closed Monday up 15.6% to just $7.39 a share — half of Thursday’s close of $14.35.
All in all, the car salesman’s share price plummeted 48% in just two days and nearly 97% year-to-date.
The culprit? Uncertainty about a finally declining car market – and investors’ concerns about Carvana’s business model after a disappointing third quarter.
What is Carvana?
Carvana is a used car dealership that combines e-commerce and vending machines to defy the traditional dealership model. Users can search for used cars online and benefit from bargain-free prices and home delivery. In some locations, shoppers can visit clear, multi-level “vending machines” that issue vehicles to waiting customers.
Carvana aims to simplify and modernize the car buying experience. And up until last quarter, his model seemed to be working…for the most part.
We’ll go into all of that below. First, let’s take a little ride down memory lane to see why the “Amazon of car buying” has faltered among investors.
A world full of (car) trouble
If you don’t live under an engine block, you’ve probably heard of the raging inflation that’s gripping the world’s wallets.
While there are many causes of the inflation caused by Covid, one could argue that the first traces crept in with a small, not-so-simple device: the semiconductor.
Let’s go back a moment.
Semiconductors and car prices: an inseparable link
In 2020, auto sales, like most out-of-home purchases, fell dramatically. To limit their losses, automakers have cut back production. Aside from declining demand for big commodities like steel and tires, they’ve also canceled or delayed semiconductor orders. (Cars rely on these tiny computer chips for everything from running the internal computer to turning on the lights.)
In the absence of orders from automakers and in the face of increased demand for higher-performance chips for computers and other electronics, many semiconductor manufacturers retooled their factories. This allowed them to transition from making autochips, a technology over 40 years old, to slimmer, more modern devices.
Unfortunately, as automakers ramped up production in 2021 to meet rising demand, they found few manufacturers able to meet their needs. Additionally, semiconductor orders are usually placed months in advance — leaving any automaker who didn’t have reserves out of luck.
This is how the rise in car prices began. As demand rose, existing supply dwindled, and chip manufacturing all but stalled, consumers turned to used cars. At one point, used car prices skyrocketed nearly 40% as dealers struggled to keep inventory on property.
Unsurprisingly, as an online used car retailer, Carvana was uniquely positioned to thrive in the pandemic. Rising car prices fueled the company’s growth as sellers collected or bartered higher prices while buyers bought up inventory as fast as the company could do business.
All good things must come to an end
But like many trends in the pandemic era, Carvana’s luck eventually waned.
In some areas, used car prices rose so much that the average consumer was completely driven out of the market. Similar inflation in other industries prompted the US Federal Reserve to raise interest rates to discourage spending and borrowing.
Over time, this combination has reduced demand for used cars. In some cases, buyers were missing a few dollars from the ever-increasing sticker prices. In others, consumers resisted rising interest rates on car financing.
And as semiconductor issues have slowly unraveled, automakers have ramped up production and, from another angle, pushed down (or at least stabilized) car prices.
Combined, these factors make for good news for consumers…and less good news for investors. In the last year, used car prices have fallen by 10.6%, which has hurt dealer prices. National franchises such as Lithia Motors and AutoNation have already reported softening market conditions.
Now, it appears that a financial reckoning has also been done for Carvana’s shares.
Carvana is having a very bad week
It’s no surprise that a faltering used car industry would eat into a used car dealer’s profit margins. Unfortunately for Carvana stock, that’s exactly what happened.
The company’s share price decline began last Thursday after the release of disappointing third-quarter financial results.
Earnings came in at $3.39 billion versus $3.71 billion expected, while losses per share were $2.67. Total net losses increased to $282 million year-over-year from $32 million.
Overall, Carvana’s gross profit plummeted 31% to just $359 million as retail sales fell 8% to 102,570 vehicles. Investors were also disappointed in gross profit per unit, which fell by over $1,100 to $3,500.
But perhaps most worrying is the company’s cash position. While Carvana’s cash and equivalents totaled $1.05 billion last year, the company now only claims $316 million to its name.
Carvana’s management blamed affordability issues, noting that monthly payments from used-car customers are up 160% from pre-pandemic numbers.
Carvana CEO and co-founder Ernest Garcia III also noted that the end of the third quarter was “the most cost-prohibitive time ever” for customers financing car purchases. “Cars are extremely expensive and very sensitive to interest rates,” he said. (Carvana pointed out that the 2-year Treasury yield, which is up 3.9% in one year, is a solid benchmark for auto rates.)
But Carvana’s management is confident it can turn the ship around…at least eventually. The company forecasts that next year will be a “challenging year” as used car prices normalize and consumers adjust to interest rates. It plans to “be a better company” as a result of these uncertain economic times.
CEO Garcia added, “While progress is rarely linear, we remain on the path to becoming the largest and most profitable auto dealership.”
The analyst rating shifts into low gear
Despite management’s optimism, a ratings downgrade in particular hit Carvana stock hard.
Influential Morgan-Stanley analyst Adam Jonas on Friday scrapped his previous price target of $68 on Carvana. In a note to clients, Jonas said: “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) pose a significant risk to the outlook that contributes to a variety of outcomes.”
Considering the size of this result, Jonas suggested that Carvana shares could fall as low as $1 or as high as $40.
As for Carvana stock, it’s likely that Jonas’ dour but uncertain report contributed to Friday’s extreme volatility.
Good for consumers… traders and investors, not so much
Carvana’s demise is on the cusp of a broadening trend in the used car market.
When car prices drop, consumers will breathe a sigh of relief. Rising interest rates and rumors of a possible recession could further fuel these declines.
But for investors, the news is less than encouraging. Lower prices and lower demand lead to lower profits and more cost-cutting measures, making short-term investors nervous.
Carvana investors, in particular, might have more reason to sweat their investment.
As a used car dealer, the company’s model is based on buying used cars for less than it sells them. But amid falling prices, recently purchased inventory has likely fallen in value, leaving smaller — or no — profit margins.
As the third-quarter earnings report revealed, per-unit earnings have already shrunk by over $1,100 apiece, with further degeneration likely if trends in the used-car market continue.
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It’s likely that Carvana’s stock is in the midst of a short-term slide that, like used-car prices, will level out over time. Then the company would prove that — like many stocks — it’s best as a long-term bet. (That is, an investment you expect to generate returns over decades, not years or months.)
In the meantime, like many oscillating Covid-era success stories (see also: Zoom, Peloton, DocuSign, and even Meta and Shopify), Carvana is having to learn to grapple with the nuances of a modern market.
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