Carvana Co. (CVNA, Financial) shot to fame in 2020 with the company offering a seamless, contact-free automated solution to shop for used vehicles online at a time when the pandemic discouraged car buyers from heading to dealerships. From around $30 in March 2020, Carvana stock reached a high of close to $360 in less than 12 months as investors got behind the company in anticipation of Carvana revolutionizing the way Americans shop for used vehicles.
The reality, however, is proving to be different from these expectations, and the company has lost more than 90% of its market value in the last 12 months. Rising interest rates have limited the company’s ability to sell finance receivables at an attractive rate – a securitization process the company is using to generate income. On the other hand, the second-hand vehicle market is showing noticeable cracks that point to a further weakening of the demand for used cars, which impacts the core business of Carvana. On Feb. 23, the company reported lackluster earnings for the fourth quarter of 2022, and the struggles seem far from over.
A poor end to a troubled year
Carvana did not end 2022 on the right foot, which is abundantly clear from its fourth-quarter financial performance. Revenue declined by 24% year over year to $2.84 billion. Retail units sold declined by 23% to 86,977. The net loss widened from $182 million in the year-ago quarter to $1.44 billion in the fourth quarter of 2022, and even when we remove goodwill impairment charges, the bottom line was still negative with a net loss of $600 million. The adjusted Ebitda margin deteriorated by close to 1,000 basis points. The company burned $800 million in cash.
For the full fiscal year of 2022, Carvana registered 6% revenue growth, but the company was nowhere near Wall Street expectations or profitability. Last December, bankruptcy rumors started floating around with the Wall Street Journal reporting the company hired a financial advisor to handle a possible restructuring of the business. Many investors rushed to short the stock as a result. In the weeks that followed, Carvana's stock price more than doubled as the short squeeze effect helped the company’s shares. However, these short-term gains should not be allowed to mask the structural challenges the company is facing today.
The only bright spots for the company came in the form of Ally Financial (ALLY, Financial) agreeing to purchase up to $4 billion in financial receivables from Carvana and the increase in used car prices in January, which suggests margin gains are on the cards for the first quarter of 2023.
Not out of the woods yet
Global supply chain bottlenecks wreaked havoc in the automotive market in 2020 and 2021, with automakers failing to meet the demand for new vehicles. Because of ultra-low interest rates and fiscal stimulus, household savings in America also reached record highs. Combined, these factors prompted consumers to pay astronomical prices for used vehicles. Used car retailers such as Carvana made the most of these favorable macroeconomic developments.
Today, tables have turned with interest rates continuing to move higher while inflation continues to create dents in the wallet. As illustrated below, Carvana’s gross profit per unit sold reached a high of $4,537 in 2021, coinciding with a peak in average used car prices. Last year, the gross profit tumbled to just $3,022 per unit.
Source: Carvana earnings presentation
Although used car prices have shown some strength this year, prospects for economic growth remain questionable, and it is too early to eliminate the possibility of a recession. Even in the best-case scenario, consumer discretionary spending is likely to take a hit this year with many companies planning to reduce their workforce and accommodative monetary policies becoming a thing of the past.
From a business reorganization front, Carvana could be too little too late. The company aggressively hired people and spent money on marketing campaigns to boost its financial performance in the last few years, and has now decided to reduce costs by turning the clock back on these decisions. Cutting costs to improve the efficiency of the business certainly seems like the right choice, but these decisions are unlikely to improve the liquidity profile of the company meaningfully this year. A liquidity crisis is not off the table despite the company having access to revolving credit facilities, and the company might have to tap capital markets to survive the ongoing macro difficulties. In other words, there is a substantial risk of ownership dilution in the coming quarters.
Takeaway
Carvana reported disappointing financial results for the fourth quarter of 2022, which did not surprise many investors who have been following the company closely. A choppy used vehicle market does not improve the outlook for Carvana, and the company is looking at a difficult path to prosperity. The stock is likely to be volatile in the short run with many traders paying close attention to Carvana because of its appeal as a potential short-squeeze play. Even from a long-term perspective, I believe Carvana seems a very risky bet as its unique business model might not be as popular without the pandemic.
