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You may remember Carvana (NYSE: CVNA), the online car retailer that almost declared bankruptcy a year ago. That same company has since experienced an astronomical surge in its stock price over the past 12 months, booking a staggering 205% increase. This massive rally might make you think that this company is unstoppable, but there’s more to the story than what meets the eye.
Even with its current rally, CVNA stock is still down nearly 90% from its peak. In fact, if you take a look at the stock’s performance over the past five years, you’d see that CVNA stock peaked at $380 in 2021, but then fell a jaw-dropping 99% to $3.63 by the end of 2022. However, CVNA’s recent comeback may lead some investors to wonder whether CVNA stock is worth investing in this year.
During the pandemic, when interest rates were near zero, and everyone enjoyed stimulus checks, Carvana was a promising auto startup and a Wall Street darling that completely transformed the car market. At its peak, it had a market cap of nearly $70 billion, which is around the same as legacy automakers like Volkswagen and BMW.
The best thing about this was that Carvana wasn’t even an automaker. The company, founded in 2012, was essentially a used car dealership that made it easy to buy and sell cars online from the comfort of your home. Then, the cars were picked up from one of Carvana’s revolutionary “car vending machines,” which were spread across the country, all without having to deal with a single car salesperson.
A big part of Carvana’s business depended on the company financing people with low credit scores. After these customers bought the cars using Carvana, the company would profit by collecting interest. However, Carvana saw a massive fall from grace when the Federal Reserve increased interest rates in 2022 because its customers’ borrowing costs increased, and as a result demand for its services rapidly declined.
Despite making billions in revenues, Carvana had never achieved profitability. As it turned out, buying, selling, and shipping cars across the country was a very expensive process that ate away at any chance of profitability.
In fact, even during Carvana’s pandemic-fueled boom, it recorded a loss of $1.6 billion in 2022. At the time, investors may not have been very concerned since the company’s revenues and car sales were skyrocketing. However, investors’ perception of CVNA stock quickly changed.
The stock market overall took a heavy hit due to the harsh macroeconomic environment brought on by inflation and high-interest rates. Carvana’s bad fundamentals exacerbated the effects – even threatening Carvana with bankruptcy.
Yet, Carvana has seemingly turned things around – posting its first-ever real profit of $782 million. Bullish investors have started buying back in, fueling the CVNA stock rally. But this doesn’t necessarily mean CVNA stock is a good opportunity. After all, how did the company manage to turn its fortunes around like this?
The answer was an aggressive cost-cutting strategy. CVNA cut its headcount by more than 4,000 people and launched a new software platform called “Carli” to support its vehicle reconditioning operations. It also implemented a pricing and sales system powered by AI, eliminating the need to input data into separate systems or spreadsheets manually. Carvana also completed a debt restructuring deal with a majority of its creditors, slashing about $1.3 billion of debt and saving the company more than $455 million in annual interest expense for the next two years.
These crucial decisions helped save the company from bankruptcy, leaving Carvana with $544 million in cash and cash equivalents as of the end of Q3 2023 – a $228 million increase from the company’s position at the end of 2022.
Besides this, CVNA reported total liquidity, including additional secured debt capacity and other factors, of $3.18 billion. Strategic cost cutting of selling, general, and administrative expenses reduced the cost per unit sold by more than $400 compared to the previous quarter, yielding a record Q3 gross profit per unit sold of $5,952.
But Carvana’s transformation is not yet complete. It is actually in the “middle of step two” of a three-step restructuring process that the CEO, Ernest Garcia III, initially laid out to investors roughly a year ago. Step one was driving the business to break even, step two is driving the business to positive free cash flow, and the final step will be returning CVNA to growth.
Will Carvana be taken Private?
According to the CEO, taking Carvana private was never an option. This is a relief to investors, but there other reasons to be bullish as well. Greacia added that the company is largely done with taking fixed costs out of its business but he believes there is room for reductions in variable costs to increase profits even more. After this CVNA will be better position to become a growth-focused company again.
Is this Sustainable?
According to JPMorgan analyst Rajat Gupta, the company is on the right path, and this strategy could give it room to improve its cost structure further. But if it is to mantin its success, it will need to drive additional operational efficiencies.
These efficiencies could come from further developing internal software and standardized processes by implementing AI technologies. After the layoff, it would also be wise to improve employee training and the career paths for new hires. If CVNA is able to optimize these aspects as well, it could help the company maintain profitability in the next quarter. As is, investors are watching CVNA’s upcoming earnings on February 22nd closely because these financial results will help determine whether CVNA’s growth is sustainable or not. Current expectations are for revenue of $2.56 billion and an EPS loss of $.80. If it surpasses expectations or even meets them, it would mark a substantial improvement from just a year ago. In Q4 2022, CVNA reported a suprise EPS loss of $5.43 more than estimates and revenue $225 million less than expectations.
If CVNA is able to achieve the 2nd and 3rd steps of its plan
CVNA Stock Forecast
While Carvana’s apparent comeback is significant, there are still a number of concerns for investors. The biggest of all is the company’s debt.
CVNA’s $2.2 billion acquisition of ADESA – a used car auction business – which Carvana bought when it was struggling to keep up with soaring demand during the pandemic, added to the company’s debt load. Although Carvana managed to reduce its total debt outstanding by more than $1.2 billion through a restructuring deal, this was actually a double-edged sword since it kicked much of the debt down the road, at higher interest rates for the most part.
The old notes, which have interest rates ranging from just under 5% to more than 10%, are due between 2025 and 2030. But its newest notes are expected to mature in 2028. All together, these notes make up roughly 78% of Carvana’s nearly $6 billion debt.
Setting these debt concerns aside, wholesale used car prices could pose another risk. These prices fell 7% year-over-year in 2023 and if Carvana faces additional competition from traditional car dealerships it will have to offer more competive prices to draw customers away from traditional dealers.
Another potential issue, is the company’s largest shareholder – Ernest Garcia II. He not only owns 24.68% of CVNA stock, but the billionaire behind DriveTime is also the father of Carvana’s CEO.
Even though DriveTime’s backing helped Carvana become successful, the connection between the two companies has brought several lawsuits against the father-son duo. In fact, the company was actually sued by two large, North American pension funds that invested in the company but then said that the Garcias ran a “pump-and-dump” scheme to enrich themselves.
If CVNA’s management team is not able to instill confidence in investors and tackle the other problems facing CVNA, then the road ahead could be rough for CVNA stock. This recent surge despite CVNA’s weak fundamentals, could be a sign to exercise some caution before making any long-term investment decisions regarding CVNA stock. For now, it might be wise to remain on the sidelines until we see more clarity on the fundamentals.
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