CVNA - Carvana's Controversial Journey: Why I'm Still Bullish

2023-12-07 08:18:01 ET

Summary

• Despite recent market softness, I maintain a cautiously optimistic stance on Carvana's potential for stability and growth.
• I'm anticipating over $400 million in free cash flow by 2024, signaling a positive shift in the company's financial trajectory.
• While recognizing the company's darkest days are likely behind, the persisting challenges, especially on the balance sheet, emphasize the need for a vigilant approach.

Investment Thesis

Carvana ( CVNA ) is a highly contentious stock. The online automotive retail platform allows users to buy, sell, and finance used cars entirely through its digital marketplace.

Even though I don't buy the argument that just because a stock is down 90%, it's undervalued, I do happen to find Carvana attractively priced.

That being said, as you'll soon see, there are clear blemishes in this investment thesis that readers should be aware of.

Nonetheless, I believe that Carvana could produce more than $400 million of free cash flow in 2024, which means that its darkest days are now in the past.

Here's why I'm bullish on Carvana.

Rapid Recap

Back in the Summer, I titled a bullish analysis , Carvana: Doubt To Dough, How Changing Your Mind Makes You Money. In that analysis I said,

I don't believe it makes sense to be bearish on Carvana any longer. I know that it's not popular to hold a positive view of Carvana's prospects, but I can't help myself.

At the core of the matter is that I don't believe that Carvana's prospects are as dire as many investors contend.

Consequently, I turn tepidly bullish on this stock.

Admittedly, in hindsight, the stock has performed better than I had expected. Simply put, I was directionally correct on Carvana to issue its BUY rating, but the stock did perform better than I expected it would. Nonetheless, looking ahead, I stand by my BUY rating on this stock today.

Carvana's Near-Term Prospects

Carvana is an e-commerce platform and automotive retailer specializing in revolutionizing the way people buy and sell used cars. The company has established itself as a key player in the online car-buying industry by providing a comprehensive digital marketplace where consumers can browse, finance, purchase, and even sell their vehicles entirely online.

In the very near term, Carvana's founder and CEO Ernie Garcia mentions in the shareholder letter the expectation of a sequential decline in retail units sold, driven primarily by industry and seasonal patterns. He states, "In the fourth quarter, we expect volumes to reduce relative to Q3 due to normal seasonality and potential industry softening observed over the last four weeks."

Furthermore, during the earnings call , Garcia described the industry-wide volume and depreciation rates affecting adjusted EBITDA and pointed to challenges in maintaining the same level of profitability in the upcoming quarter. Garcia notes, "The sum of these dynamics leads us to expect to produce another great quarter, but as in past Q4s, we expect lower industry-wide volume, coupled with higher industry-wide depreciation rates to cause lower adjusted EBITDA than we have achieved in the past two quarters."

Next, Carvana's executives acknowledged a recent softening in the market, attributing it to both industry-wide trends and unique conditions. According to Garcia, there have been some recent signs of softness, "It looks like things have probably been a bit softer, not to a degree that I think is unique or merits a ton of attention, but definitely that's been the direction."

Furthermore, the CFO, Mark Jenkins, emphasized the unique nature of the market in recent years, making precise forecasting challenging. He stated, "The last several years have been very unique. I think there's been a ton of distortions in the market that have made things a little bit harder to kind of precisely forecast." This recognition underscores the complexity and volatility in the automotive sector, with various external factors impacting Carvana's ability to predict market trends accurately.

Given this background, let's attempt to form a view on 2024.

Revenue Growth Rates To Stabilize in 2024

Looking ahead to 2024, it won't take much for Carvana to start delivering stable growth rates. Indeed, even if this business isn't able to see much topline growth, the fact that the business has started to reach stability immediately implies that the question of bankruptcy is off the cards.

And when a business goes from ''will it survive'' to ''could this at one point thrive'' there are meaningful changes. For one, the shareholder base becomes slightly more optimistic. Next, this makes it easier to hire top executive talent, and finally, and of crucial importance it will make raising funds meaningfully easier for Carvana.

To put this more succinctly, Carvana's darkest days are now in the rearview mirror. Looking ahead, there are still significant blemishes to the investment thesis, but the question of survival is now less meaningful.

Main Detraction to the Bull Case

Carvana holds about $545 million of cash and equivalents against $3.2 billion of debt.

The concerns about Carvana's balance sheet are indirectly hinted at through the mention of a corporate debt exchange offer. During the earnings call, CFO Jenkins mentions, "On September 1, 2023, we closed the previously announced corporate debt exchange offer with 96.4% of note holders agreeing to exchange $5.52 billion of our unsecured notes for cash and new secured notes, reducing total debt by over $1.325 billion, extending maturities and decreasing required cash interest payments by more than $455 million per year for the next two years."

Essentially, Carvana's balance sheet has started to improve ever-so-slightly. Most likely since creditors are perhaps less apprehensive of Carvana's long-term prospects and ability to generate some stable free cash flow.

CVNA Stock Valuation -- 17x Forward Free Cash Flow

Carvana's EBITDA will be around $380 million in 2023. However, management is determined to improve its EBITDA prospects and has consistently guided for strong EBITDA in 2024.

To be conservative I estimate that Carvana's EBITDA in 2024 will reach approximately $550 million. This is a figure that I believe to be realistic. I recognize that bulls probably deem this figure to be too conservative, but it appears to be a realistic figure.

Furthermore, Carvana has noted that its capex requirements in 2024 will be around $100 million, a figure that is line with 2023. Therefore, when all is said and done, it's possible that Carvana's free cash flow in 2024 could reach about $400 million.

This puts Carvana priced at about 17x next year's free cash flows. That's not expensive if one buys into Carvana's prospects as being a lot more stable.

But as I noted already, the business has ample blemishes that need to be considered too, specifically pertaining to its balance sheet.

The Bottom Line

In conclusion, navigating Carvana's trajectory presents a nuanced challenge.

Despite acknowledging the recent softness in the market and recognizing the intricacies of industry forecasting, my bullish sentiment on Carvana remains tempered but resilient.

The anticipation of over $400 million in free cash flow by 2024 signals a positive shift, though the balance sheet's weight and ongoing efforts for improvement merit scrutiny.

What particularly catches my attention is Carvana's valuation, priced at around 17x next year's free cash flows. That's a fair entry valuation for this stock.

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