CVNA - Carvana: A Buy Ahead Of The Summer

2023-05-09 00:26:36 ET

Summary

• Used car season is underway and Carvana will be able to offload more vehicles from its inventory.
• Used car prices increased in Q1 and could further climb as the Fed hinted at not hiking rates any further.
• Turnaround plan moving in the right direction which would see CVNA shift its focus back on growth.
• Bankruptcy remains a viable outcome as the debt situation is still alarming.

After posting promising Q1 earnings, Carvana Co. ( CVNA ) appears to be on the right track to rebound from its financial failures. While CVNA has revolutionized the used car market, the company’s attempts for growth have proven to be costly for shareholders as the stock is nowhere near its highs.

However, the outlook may be brighter for CVNA as the used car retailer is moving according to its plan to get its business back on track. Moreover, the used car season just started and CVNA is in a great position to increase sales and offload its inventory with used car prices surprisingly increasing in the first quarter of 2023. With the Fed potentially pausing interest rate hikes and the used car season underway, used car prices may continue climbing this year - which makes CVNA stock a buy at current levels.

Attempting To Recover

In Q1, CVNA reported a mostly positive report as the used car retailer reported an improved net loss of $286 million compared to $506 million a year ago. With this in mind, CVNA was able to achieve this feat thanks to its efforts to turn around its business by cutting costs and focusing on profitability. In that regard, CVNA successfully reduced its operating costs from $727 million last year to $472 million.

In addition to reducing its operating costs, the Q1 earnings report highlighted CVNA’s success in bringing down its inventory levels from $1.8 billion to $1.4 billion and boosting its non-GAAP total gross profit per unit to $4,796, a YoY increase of $1,811 and the best Q1 GPU in the company’s history. Through these actions, CVNA is now closer than ever to profitability. However, achieving profitability comes at a cost, and in CVNA’s case, it comes at the expense of revenue growth. In Q1, CVNA sold 79.2 thousand vehicles - a 25% YoY decline - causing its revenues to drop from $3.4 billion a year ago to $2.6 billion.

While declining revenues at such a rate is usually a concerning sign, CVNA’s revenue decline was a main result of reduced advertising and inventories which shows that CVNA is on the right track to successfully achieve its turnaround plan to become the largest and most profitable automotive dealer once again. On that note, CVNA’s plan is based on 3 pillars realizing a positive adjusted EBITDA, a significantly positive unit economics and finally achieving growth after completing the first two steps.

So far, CVNA is on the right track to achieve this plan as the company improved its adjusted EBITDA loss to $24 million from $291 million in addition to improving its GPU to a Q1 record. With this in mind, CVNA expects to report a positive adjusted EBITDA in Q2 and if the used car retailer continues cutting costs at the same pace, it could successfully achieve this feat.

Used Car Season Is Underway

With the used car season underway, CVNA has a golden opportunity to post impressive Q2 earnings thanks to the increasing demand for used cars in the spring and summer months. In this way, CVNA could inch closer to profitability if it continues to cut its costs. Typically, the used car season contributes to a 10%-15% increase in used car prices. If used car prices witness a similar increase this year, CVNA could be set for an extremely bullish Q2 earnings report considering it’s when the company posts its best revenues every year.

Looking at the chart, CVNA ran 210% from May to August. In a similar fashion, CVNA replicated such a run in 2021 and 2022 when the stock ran 70% and 103% respectively. With the used car market starting recently, CVNA could be on track to witness a similar run, especially with the improving macro environment.

A Bullish Macro Outlook

While inflation is proving to be a sticky issue to the Fed’s efforts to curb the growing inflation rates, the macro headwinds could be coming to an end as the Fed’s Chair Jerome Powell may have hinted that no further interest rate hikes should be expected as he stated “We're no longer saying that we anticipate".

Now that the Fed may not continue raising interest rates, used car buyers may be more inclined to purchase vehicles as interest rates may stabilize. While it is likely that CVNA’s revenues will continue to decline YoY as a part of the company’s plan, the expected growth in the demand for used cars may push CVNA closer to its goal of bringing down its inventory and reaching profitability. If CVNA posts impressive Q2 results as I expect, then it would be on its way to reaching a peak next August which makes adding CVNA at current levels a mouth-watering opportunity.

Risks

Although the shifts may be tiding for CVNA, investing in the stock holds significant risks. The main risk associated with CVNA is bankruptcy since the company holds $8.5 billion in debt compared to its cash balance of only $488 million. If CVNA’s efforts to turn around its business do not prove to be successful, then a Chapter 11 filing may be the only way out of the company’s excessive debt balance.

Another risk to consider before investing in CVNA is that the company’s expectations of reporting positive adjusted EBITDA in Q2 may not be sufficient to turn around the business. Since CVNA has a substantial amount of debt on its books, the company incurs a significant interest expense - $159 million in Q1 - that would not be accounted for in adjusted EBITDA.

Moreover, adjusted EBITDA does not consider depreciation - which amounted to $93 million in Q1 - which is an extremely important expense to CVNA’s considering its bloated inventory. Since interest and depreciation expenses are an integral part of CVNA’s business, posting a positive adjusted EBITDA may be irrelevant to the company’s current situation.

Technical Analysis

Looking at the daily, CVNA is in a neutral trend with the stock trading in a sideways channel between $6.68 and $10.26. Following its Q1 earnings, CVNA climbed by as much as 55% due to the bullish sentiment surrounding the company’s expectations of positive adjusted EBITDA in Q2.

However, I believe the stock will cool down from this run in the near term once investors realize that adjusted EBITDA is an irrelevant metric for a company in CVNA’s situation. With this in mind, I would wait for the gap near $7.2 to fill before buying for the summer pump to capitalize on the growing demand for used cars in the used car season and ride the wave until CVNA reaches its peak in August as I expect.

Conclusion

While bankruptcy is a serious risk for CVNA, the outlook could be bright for the used car retailer as it navigates through its turnaround plan. With the company working to cut its costs and bring its inventory levels down, CVNA’s fortunes may shift in the long term as it could reach profitability. Now that the used car season is underway, investors could wait for CVNA to cool down from its recent run on expectations of positive adjusted EBITDA in Q2 to buy the stock ahead of its seasonal run.

With the used car season underway, CVNA is a buy ahead of its seasonal run that could be fueled by its improving financial situation.

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