Posted inUsed Cars

After an 83% Rally, is Carvana Safe to Buy Now?

CMS’s Journey To Worth-Primarily based Care
CMS’s Journey To Worth-Primarily based Care

Considering the state of the used-car market, rising interest rates, and other headwinds hampering it right now, Carvana (CVNA 6.55%) may wish it could sell snacks, soda, and chips out of its vending machines instead of vehicles.

But for risk-tolerant investors looking for a beaten-down stock, could Carvana’s 83% surge so far this year be a signal that it’s time to jump back on board the company that was once a Wall Street champion?

Emergency brake engaged

Carvana’s primary investor narrative during the first few years was explosive growth. It wasn’t unusual for investors to crack open a quarterly report and see year-over-year growth in the triple digits for revenue and units sold.

Bar graph showing rapid rise in retail units, followed by a decline in 2022.

Image source: Carvana’s Q4 letter to shareholders.

Oh, how quickly things change. Due to market headwinds and rising interest rates, which made used cars less affordable, the company had to pull the emergency brake on its growth and switch gears to reduce costs and improve profitability.

This change in priorities has been absolutely necessary. The company is burning through cash at an unsustainable pace, putting it in a difficult position with investors as it might need to issue shares to raise capital, take on even more debt, or potentially restructure its business. The graph below shows the company’s cash levels as well as the rate at which it’s burning through that cash.

CVNA Cash and Equivalents (Quarterly) Chart

CVNA Cash and Equivalents (Quarterly) data by YCharts

Problems and solutions

If Carvana can’t reduce its cash burn fast enough, raising capital will bring different problems. If Carvana issues additional shares, it will not only be doing so at low share prices, but it will further dilute investors.

If Carvana takes on more debt, it will only add to its interest expense woes. For context, Carvana’s interest expense jumped from $176 million in 2021 to $486 million in 2022.

The bad news is that even without taking on more debt, the interest expense figure is likely to jump closer to $600 million in 2023. The interest cost of its most recently issued 2030 senior unsecured notes was only partially felt in 2022, but the full cost will hit in 2023. That’s because Carvana makes interest payments on those notes bi-annually, and its first payment was in November.

Carvana’s current and future interest expense levels are a significant issue when you consider that the company’s full-year 2022 total gross profit was only $1.25 billion, and its net loss was checked in at nearly $1.6 billion. In other words, Carvana’s interest expense is a big problem that some overlooks as it doesn’t impact the adjusted earnings that many read during quarterly reports.

With those complications to raising capital, management’s focus on reducing costs and improving profitability to reduce cash burn is essential to the company’s survival in the near-term.

So what is management doing specifically to reduce cash burn, and is it time to jump on board the stock’s 2023 rally?

The game plan

By the second quarter of 2023, management expects to reduce its selling, general, and administrative (SG&A) expenses by over $1 billion compared to the first quarter of 2022. It also believes that reduced inventory and increased unit turn rate can help push gross profit per unit (GPU) back to levels over $4,000, which would be a major step to achieving positive adjusted EBITDA at its current volume.

While positive adjusted EBITDA is a solid first step, it’s not the end goal for management’s game plan, which is to become free-cash-flow positive, and then to return to growth. Returning to growth is definitely in the distant future, but if Carvana becomes cash-flow positive, it would be a massive sign to investors that the company can get through this rough period and reward their investment down the road.

Right now, the company’s rally in 2023 is not a signal that investors should jump back on board, at least not yet. The rally may be short-lived, and most likely just a little relief for the stock price as used-car prices have ticked up recently. Management is taking pivotal and critical first steps for its business, but until progress is made in significantly reducing cash burn, there’s likely too much risk for many investors who have other options in the automotive industry.