CVNA - Carvana: Closer To The Brink

2023-05-08 14:57:10 ET

Summary

• Carvana's balance sheet continues to get worse.
• Company debt exchange isn't progressing as hoped.
• Profitability hopes could be dashed if the US sees a recession.

Last Friday, one of the market's biggest winners was Carvana ( CVNA ). Shares of the online vehicle sales platform jumped nearly 25% after the company reported its first quarter results . While investors cheered a few of the major headlines coming out, there are still a number of significant issues here that certainly need to be addressed.

Carvana reported Q1 revenues of $2.61 billion. While this slightly beat street estimates, the company had guided lower for this period and the average street revenue expectation had dropped by more than half a billion dollars since the Q4 report. This revenue print was a more than 25% drop over the prior year period. As the chart below shows, retail unit sales were their lowest in more than two years.

For the longest time, Carvana was spending excessively to grow retail units sold and thus revenue. Last year, however, management finally realized that the process was not sustainable. Since then, unit sales and revenues have come off their peaks, while the company has looked to trim as many expenses as possible. One of the main reasons why the stock bounced on Friday is that management expects to generate positive adjusted EBITDA in the current quarter.

The problem is that adjusted EBITDA is only one metric, and it doesn't tell the entire story. It's also not equivalent to true profitability, like many headlines last week suggested. For instance, Carvana's net debt position increased slightly in Q1 2023 to nearly $8 billion, an end-of-quarter record. With some of that debt being variable rate, higher interest rates have increased interest expenses, which are now running at a $636 million a year pace. Carvana is trying to refinance some of its debt, but the current exchange offer has been extended twice so far, which says that bondholders aren't exactly jumping on board with the move.

Management can talk about all the progress that it has made recently, but free cash flow was nearly negative $100 million in Q1. As the chart below shows, this is despite a cash flow statement tailwind of a $385 million reduction in inventory. The company has reduced total inventory by almost $2 billion from its peak, yet it is still burning cash. When this key balance sheet item ceases being a major cash inflow, and perhaps even becomes a headwind again, overall cash burn could tick back up even if net losses come down a bit.

Inventory can't go to zero here, or sales will continue to fall, and management has already guided to lower retail unit sales for Q2. The Manheim index is already off to a weak start for the quarter, and we really haven't seen the full impact of all the corporate layoffs announced in the past year or so yet. US economic growth is expected to weaken in the second half of this year, with a recession possible, and that's certainly not good for auto sales. The Federal Reserve might even raise interest rates again if inflation data doesn't improve soon, providing more headwinds for Carvana.

With a market cap of about $1.6 billion as of last week's finish, current investors could get crushed with a massive amount of dilution if bondholders get their way with a debt for equity swap. The company's available liquidity has come down a lot recently, with more than half of it just being unpledged real estate. Taking on more debt here, especially at high interest rates, only hurts the timeline to get to positive GAAP profitability and free cash flow.

While Friday's near 25% jump looks nice, there are a number of things to remember here. First, the stock had rallied to $11.19 at its peak and ended up closing below $9. Also, this was a name that traded at more than $300 at its peak, so it is down well over 95% since then. The average price target on the street is under $10, so the projected upside isn't tremendous when you consider that bankruptcy or significant dilution could easily crush this stock.

In the end, Carvana's chances of survival may not have actually increased recently. Despite lots of positive talk from management last week, the balance sheet got worse again in Q1. Without another huge inventory drawdown, cash burn would have been several hundred million dollars, and higher interest rates are only hurting this debt heavy company. Shares may have jumped on Friday, but they lost a good chunk of their peak gains, and Carvana could be in major trouble if the US does have a recession later this year.

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