CVNA - Carvana: Not Out Of The Woods Yet

2023-07-20 09:43:54 ET

Summary

• Carvana's stock has risen almost 100% over the last 30 days and close to 30% in Wednesday's trading, following a restructuring of its capital structure.
• The restructuring includes an equity issuance of up to 35M shares or up to $1B in value, and the option to roll over debt due in 2028, 2029, and 2030.
• Despite the positive restructuring, the company's top-line performance continues to deteriorate, with total units sold and revenues both down significantly year-on-year.
• Unit profitability, however, has improved significantly.
• Overall, recent news is a mixed bag, and the firm is not out of the woods as to its fundamentals, yielding a hold rating for the time being.

Overview

Carvana (CVNA) stock has been on a tear in the month leading up to its latest earnings report, with this momentum continuing through Q2 '23 earnings results. The stock is now up almost 100% over the last 30 days and was up close to 30% Wednesday in the wake of its latest earnings print.

This share price performance has come along with material improvements in its fundamentals as well as a high-profile restructuring of its capital structure, which is being implemented through both debt and equity financing. While many observers had thought that the company was slated to enter bankruptcy, the firm appears to have dodged this outcome - at least for the time being.

Of course, it is possible that the share price has now gotten ahead of what the fundamentals truly imply. In this article I will review what's changed and how things should shape up for the stock going forward.

Commentary On Capital Structure Changes

The elephant in the room for Carvana has long been its significant levels of debt. As mentioned the firm has now restructured its debt. Seeking Alpha reported that Carvana entered into a transaction support agreement with its largest creditors, a deal which will reduce its cash interest expenses by $860M for the next 8 quarters. It's worth evaluating this in more detail.

The structure of this deal allows Carvana to remove up to 83% of the principal that was due to be paid for its 2025 and 2027 debt obligations. This is to be accomplished through an equity issuance of up to 35M shares or up to $1B in value. The firm has also gained the option to roll over debt that it has due in 2028, 2029, and 2030. It is worth noting that the firm is obligated to repurchase its 2025 principal outstanding through cash raised from this new equity issuance and that is obligated to issue at least $350M in new shares to accomplish this.

This part of the agreement means that Carvana now has a standing option to raise up to $1B through the issuance of new shares and that it is again obligated to issue at least $350M in new equity towards this objective. At Carvana's current market capitalization of $7.3B this represents a dilution for shareholders of at least 4.8% and up to 13.7%.

On the debt financing side, Carvana has gained the option to roll over significant portions of its outstanding debt, up to $4.4B in total.

Given the complexity of this agreement, it is difficult to ascertain exactly how this will net out for the firm's share price. At a minimum we can rest assured that it has newfound flexibility and that it will be diluting equity shareholders in the amounts mentioned above. The most certain aspect of this is that Carvana will dilute equity shareholders somewhere between 4.8% and 13.7% between now and 2025. The implications of the debt restructuring are less certain but overall allow the company to push back significant amounts of its debt outstanding.

While this should allow the firm to stave off bankruptcy, make no mistake - these bills will still come due. I will reiterate that the firm is opting to dilute equity shareholders in the near-term to continue servicing its debts and that it has gained the option to push its longer-dated debts further into the future. The essence of what this is in the near-term is essentially that the firm is converting debt obligations into equity dilution. This is better for bondholders than it is for stockholders.

Additional implications of this restructuring will play out in the decisions that the firm makes over the next few years, decisions which should be watched carefully by investors. The reaction from the market, then, can be interpreted as optimism that Carvana can make good use of its newfound breathing room.

Commentary on Q2 Earnings

While it is well and good that the firm has reoriented its capital position and garnered additional time for improving its operations, we must of course look at the quality of its operations to see how things have progressed here. Ultimately, if these variables are not moving in the right direction, then the capital restructuring won't achieve much over the long-term.

Here the picture is mixed. The company has continued to see deterioration in its top line performance, with total units sold and revenues both down significantly y/y. This trendline should not be considered sustainable and I personally would like to see the firm return to top-line growth before becoming genuinely optimistic as to its long-term prospects.

As to unit profitability, Carvana appears to have made significant strides. Gross profit per unit is up 94% y/y and the firm's net loss has improved to -3.5% for this most recent quarter. This has come along with an overall reduction in its cost structure of $1.1B over the last 12 months, a reduction which management expects to persist.

Furthermore, the firm achieved positive adjusted EBITDA this quarter and issued guidance that it will do so in the next quarter as well. Personally I am not inclined to read too far into this as it is a non-GAAP metric.

Overall, I will reiterate that recent news is a mixed bag. The top-line is still on a downward trajectory and GAAP profitability has not been achieved. While Carvana has gotten closer to profitability, it is still not quite there.

Conclusion

Carvana is far from being out of the woods. The bright side of this latest report is improving unit profitability and additional breathing room. As to everything else, there is still work to be done.

This has played out in the firm's level of outstanding short interest, which is now the lowest it has been all year at 39.1% of its float, which is still a significant number.

Looking at this chart, it is clear that there has been significant short covering that has driven the share price up. There is still plenty of dry powder in this regard and the firm's share price could be further buoyed by additional shorts covering their positions. On the other hand, 39% of the firm's float being shorted implies ongoing - and significant - bearish sentiment.

Considering all of this together, I am going to rate this stock a hold for the time being. Readers of my previous article can note that my recommendation was to enter this security on a tactical basis, a trade that has performed quite well. At present, I think the next quarter is a lot less certain and would be cautious. Ultimately, there has not been enough progress on fundamentals for me to consider this a buy for the long-term, and I believe that short-term upwards price effects have already played out.

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