Carvana – Car Wreck (NYSE:CVNA)

Shares of Carvana Co. (NYSE:CVNA) have been decimated. A $360 stock a little over a year ago now trades at just $14, marking a staggering 96% loss for investors over the time frame over just over a year.

The truth is that I was never carried away with the shares. In May 2017, I concluded that the cash burn and lack of operating leverage rightfully scared investors. With shares hitting the $100 mark early in 2020, and hitting a high of $360 in 2021, I looked awfully stupid as I voiced this concern in spring of 2017. By now we are back to the levels at which shares were trading in 2017, and the situation is outright scary here.

Some Perspective

Carvana went public in May 2017, as I labelled the public offering to be a disaster, with investors not willing to finance the growing losses. Given a significant cash burn, I concluded that investors should fully expect dilution in the medium term. At the same time, I noted that the potential was great, in case the company would be succeeding in its ambitions, yet investors were clearly focused on the risks at that point in time.

The promise of Carvana was to disrupt the practice of buying used cars with its online business model. Carvana offers a wide selection of used cars, as the most distinguishing factor was the transparent pricing. 360 imaging technology allows consumers to inspect vehicles online, to be followed by purchase and financing. Consumers could elect to either pick up the car from its characteristic vending machine, or have it delivered at home.

Ahead of the offering, the company had over 7,000 vehicles in inventory, having sold a cumulative 27,000 vehicles in the period 2013-2016, with many of these sold in 2016, a year in which the company reported sales of $365 million. That was a relative small revenue base in a used vehicle market which totaled more than $700 billion in 2015, made up across nearly 40 million transactions, dominated by a large group of independent operators.

The goal of the online model was to offer wider selection, uniform evaluation of quality, and reducing the overall hassle of buying a car.

The company went public at $15 per share in 2017, as shares fell to $11 on their opening day. At the offer price, equity of the company was valued at just over $2 billion. This was applied to a business which generated $365 million in sales in 2016 (up 180% on the year before) as gross profits of $19 million (equal to 5% of sales) looked minimal. This was certainly the case as operating expenses of $109 million resulted in an operating loss of $93 million.

With pro forma cash balances seen at $215 million, the burn rate was quite worrying, even as the company does not have ¨regular¨ debt outside floorplan facilities, loans used to finance the inventories.

Boom – Bust

The boom, in which shares essentially increased a factor of 25 times from the offer price, and subsequent 96% fall, has been referred to already above. The reason for that is (somewhat) understandable, as the company has seen phenomenal growth. Early in 2021, the company reported 2020 results with sales up 42% to $5.6 billion, a 15-fold increase from 2016. Gross profits of $794 million rose to 14% of sales, as the company still posted an operating loss of $462 million that year. This was up from 2016 as well, of course, but on a relative front a lot of progress has been made, albeit that losses were still very substantial in relation to the gross profitability of the business.

Revenues rose an unprecedented 130% to $12.8 billion in 2021, with the markets being very strong. Gross profits rose to $1.9 billion as operating losses narrowed to $286 million. The balance sheet has exploded given the growth and this growth and losses made that net debt has been inching up to $5 billion as the equity cushion of the firm has been minimal, at around half a billion on a seven billion balance sheet. More growth was seen as the company announced a multi-billion deal for ADESA´s physical auction sites as well, yet that deal might now perhaps bankrupt the business.

In April, Carvana reported its first quarter results. Concerns about margins and higher interest rates made that shares had already fallen to $100 at the time. While first quarter sales did rise 56% to $3.50 billion, actual gross profits declined a bit to $298 million as operating losses increased from $82 million to $506 million as a result of the margin pressure, wiping out all the equity on the balance sheet.

The company specifically cites higher interest rates and the financing of the purchases as risks, but the intentions of management remained good with CEO Ernie Garcia handing out 1 million shares to its team members, each of them given 23 shares with a value of $2,300 at $100 per share. A few days later, the company sold 15.625 million shares at $80 per share, in order to raise more than $1.2 billion to shore up the balance sheet. Ironically, CEO Garcia actually bought 5.4 million shares in this offering, as a vote of confidence. This was still ahead of the $2.2 billion deal for the ADESA US Physical Auction business, which closed in May.

Second quarter revenues were up just 16% to $3.88 billion as gross margins were down to $396 million. A $438 million operating loss was a bit better than the first quarter results, but this is a seasonally stronger quarter as the company actually posted an operating profit of $45 million this quarter last year.

And Now?

With 186 million shares and units outstanding here, the company now has a $2.8 billion equity valuation, standing in sharp contrast to a more than $50 billion peak valuation. The reasons for that are plentiful and right, as inflation and higher interest rates means that used car prices are falling, and their ability to be financed is rapidly falling, raising serious doubts on the future of the business here.

With a current burn rate of around half a billion, no shareholder equity left, and the balance sheet being heavy and including a lot of more expensive debt, the situation is dire. With shares down 96%, it looks dangerous to short the stock, as a FED pivot might easily trigger a short squeeze. Perhaps a better capitalized or traditional player sees potential in this business model. After all, the business model is quite innovative, yet unprofitable so far as the growth acceleration (including debt and M&A) came at exactly the peak of the market.

Despite perhaps a lifeline being thrown at the business, it is the fundamentals which paint a red picture as my base case is that of bankruptcy some point down the road. As it appears: five years after the IPO, these concerns proved the initial scare of investors at the time of the offering right, albeit that investors have seen a huge rollercoaster ride in the meantime as well.