Carvana Stock: Another Chance To Sell (CVNA)

Back in early November, I warned investors that single digits for shares of online vehicle retailer Carvana (NYSE:CVNA) were possible. The company had just reported another ugly quarter, and the near term future wasn’t looking very bright. While shares dropped tremendously afterwards, they have recently stormed back in a dramatic way. In my opinion, that gives investors another chance to sell.

In recent days, we’ve seen a return of the “meme” stock rally. Bed Bath & Beyond (BBBY), which recently warned about potential bankruptcy, has seen its shares more than triple. Names that surged in the past on these frenzies like AMC Entertainment (AMC) and GameStop (GME) also rallied, with Carvana joining in as well this week. Carvana is one of the most shorted names out there, and shares surged 46% on Thursday to over $8 a share, more than double the recent low of $3.55. Of course, they are still down tremendously from my previous article when they traded around $13.

The main problem for Carvana currently is the decline in used vehicle prices. As the chart below shows, used vehicle prices have been coming down for months now, with the CarGurus index down 5.7% in the past 90 days alone. On the retail side, which makes up the most sales, average selling prices dipped by $900 a unit sequentially in Q3, and are likely to fall further when Q4 is reported. In theory, every vehicle that Carvana purchases is losing value every day until it can be sold, which could also compress the company’s gross margins moving forward.

At the same time, Carvana has recently slowed the number of vehicles it has bought. The company saw its inventory balance balloon to around $3 billion, but it has come down lately. In an effort to reduce losses and cash burn, management was forced to slow revenue growth by limiting the number of vehicles it bought. At the same time, selling fewer cars at lower prices means the company can’t make as much money on the vehicle loans it is selling.

For a while, Carvana shares were an investor favorite because of its revenue growth profile. Unfortunately, for the reasons mentioned above, total sales are not rising at the moment, and analyst estimates shown below don’t see growth returning until the back half of this year. Even that Q4 2023 revenue estimate, however, would still be about 10% below the company’s quarterly peak of $3.88 billion reached in Q2 of last year.

The problem with this revenue picture is that it can’t support the company’s expense base. In Q3 2022, for example, total expenses were nearly $3.9 billion, which is well above any quarterly revenue level expected to be seen in the near term. Management has certainly taken actions to cut costs, like reducing the company’s workforce, but profitability remains quite elusive. The company lost almost half a billion dollars per quarter during the first three quarters of 2022, although almost half of those losses were attributable to non-controlling interests.

Carvana finished Q3 in a net debt position of around $7 billion. Some of that is variable rate debt, which is only getting more expensive by the quarter as the Federal Reserve continues to raise rates. With large losses expected to continue for some time, each additional quarter of cash burn results in more borrowings against the company’s credit facilities. Added interest expenses there only make profitability and positive cash flow harder to achieve.

Realistically, the company needs an equity infusion, but that’s very hard to do with now with a market cap that’s only around $1.5 billion. When you are burning a billion dollars or more of cash a year, even a half billion dollar raise right now would significantly dilute investors. As a reminder, there were about 106 million Class A shares as of 10/31/22, and those are the shares that trade in the market. There were also 83 million Class B shares that don’t trade, but can be exchanged for Class A, with an explanation of this conversion process being found on page 23 of the most recent 10-Q filing.

At the moment, Street analysts still believe in Carvana to some extent. The average price target of $11.47 implies significant upside on a percentage basis from Thursday’s close. However, that average valuation was above $350 just a year ago, and was still at $44 going into the Q3 earnings report. If we get another bad set of results with the Q4 report, I expect more target cuts to come, bringing the average down into the single digits. The stock did jump above its 50-day moving average at $6.83 on Thursday, but that key technical trend line is still declining. Should the stock fall back below it, it likely will add more pressure on the downside.

In the end, the recent surge in shares of Carvana gives investors another chance to sell the troubled name. Used vehicle pricing continues to decline by the week, which is likely to pressure the company’s revenues and margins. While management is working to reduce expenses, losses and cash burn are still very high. A troubled balance sheet is not a good setup in a rising interest rate environment, and we could see another Fed rate hike in a few weeks. A much needed equity raise would be very painful at this stage, but if this business gets any worse, it might be the only way to prevent bankruptcy.