CVNA - Carvana Stock: Bulls And Bears Might Lose Big

2023-10-13 12:20:43 ET

Summary

• Carvana's stock dropped due to an analyst rating update, highlighting the company's volatility and weak financial health.
• The company's recent financial results showed a decrease in sales and a net loss, although there were some improvements compared to previous quarters.
• Carvana's debt exchange and credit rating downgrade raise concerns about its ability to meet obligations, while the used car market in the U.S. also faces challenges.
• But do not rush to sell CVNA stock short.

Carvana Overview

Carvana Co. ( CVNA ) stock dropped yesterday because one analyst updated his rating on the company. Chris Bottiglieri, an analyst working for Exane BNP Paribas, issued a "neutral" rating on the stock. The problem here is that the analyst had previously believed CVNA would outperform the average returns for the S&P 500 (SP500).

You might be wondering why CVNA stock dropped yesterday by almost 11% for such an unimportant reason. The reason for this is the company's extreme volatility and lack of strong financial health.

CVNA Stock News

Carvana Co. stock is up more than 600% year-to-date. According to Finviz, that is better than any other stock with a market cap of at least $300 million.

Since my last article on Carvana, the company reported its Q2 2023 results . In the second quarter of 2023, Carvana's sales decreased by 24% year-over-year. The company's quarterly net loss totaled more than $100 million. This was a great improvement from the prior year period. However, this is not an excellent set of results, indeed.

As we can see from the two tables below, Carvana has reported somewhat better quarterly earnings compared to Q2 2022, Q3 2022, Q4 2022, and even Q1 2023. The Q2 2023 revenues were also better compared to Q1 2023 and Q4 2022.

Source: Carvana's website.

Source: Carvana's website.

When Carvana's stock traded at all-time lows at the beginning of 2023, the market expected Carvana to file for bankruptcy. That is why its stock traded at ultra-low valuations. The stock price was less than $8 per share, whilst the P/S ratio was about 0.03, a record low, indeed.

But Carvana did not file for bankruptcy. The company was helped by a substantial debt restructuring. It aimed to lower cash interest expense by over $430 million per year for the next two years. Carvana also decided on an equity offering of 35 million shares that should raise more than $350 million. The latest debt agreement struck in July 2023 will eliminate more than 83% of Carvana's unsecured notes maturing in 2025 and 2027. The noteholders will now receive new notes secured by Carvana and Adesa assets.

Interestingly, my last article on Carvana published on 6 July 2023 was titled "Carvana: Shorts Might Get Burned." The debt exchange was announced on July 19. On that day, CVNA stock surged by 40.2%. According to estimates from analytics firm Ortex , about 54% of Carvana's publicly available shares were being shorted as of 18 July. So, unfortunately, the short-sellers ended up recording a book loss of about $500 million over one single trading session. However, S&P, the credit rating agency, downgraded the company's debt soon after the deal was announced. I will cover this in some more detail in the section on financials.

Noteworthy is that the rating downgrade comes soon after Carvana's rival Shift Technologies (SFT) filed for Chapter 11 bankruptcy . Shift Technologies failed to get money to finance its ongoing operations. Carvana, however, avoided going out of business earlier this year. But the downgrade to "neutral" could have also been due to the used car market in the U.S. facing problems. Moreover, the post-recovery CVNA stock price surge could have also been far too high. In other words, there might not fundamentally be enough stimuli for the stock price to grow because it is already far too high. I will cover these points in some more detail in the next sections of this article. Let me get to the company's financial fundamentals.

Carvana Financial Fundamentals

The company's financial strength indicators are still quite mediocre, I would say. As can be seen from the excerpt below, the debt load is still high, whilst the equity and the EBITDA are negative.

However, the company is not running out of cash tomorrow. Its liquidity position is still quite reasonable. The current and the quick ratios are above 1, which is acceptable.

S&P, however, views the proposed exchange as a serious threat . In the agency's opinion, the company is highly likely to default if the debt exchange gets completed because Carvana's creditors will get less money than originally promised. The negative outlook suggests that the agency expects to lower the issuer credit rating to D (default level, that is) as soon as the debt exchange is completed.

This might look strange given the fact the proposed transaction will extend Carvana's maturities and cut the interest costs thanks to the PIK option. But the problem is that the:

"principal amount of the new securities offered is lower than the original par amount, the new maturities extend beyond the original dates, and the timing of payments will be slower by adding a PIK feature. In addition, debtholders are essentially being primed by the senior position of the new notes."

In short, in S&P's view, if the company does this exchange, it will admit its inability to meet its obligations.

CVNA Stock Valuation

On the surface, it seems like Carvana's stock is fairly valued. After all its price-to-sales (P/S) ratio is only about 0.3. But bear in mind that it is a company that has recently just avoided liquidation.

Let us also look at its EV-to-EBITDA and P/B ratios. As I have mentioned above, the company has negative equity and negative EBITDA.

The last reported positive EV-to-EBITDA ratio of Carvana was a whopping 1313. Only in 2022 did Carvana have a positive EV-to-EBITDA.

Only at the end of 2022 did Carvana have a positive book value. Its last reported positive P/B was 1.83.

So, at the very least we cannot say that Carvana's stock is good value for money.

Downside Risks

The risks to Carvana Co. are very substantial, in my opinion. To start with, the market for used cars in the U.S. is facing hardships. First and foremost, the interest rates on car loans are very high, and many consumers borrow in order to buy a used car. Add to that the fact the inflation readings are quite high right now, which is bad news for consumers' purchasing power. So, the current environment is not very bullish for Carvana and the industry.

The situation might get more complicated, given the company's financial position and the risks related to the recent debt exchange. Moreover, a recession might provoke bankruptcy since consumer demand might fall to all-time lows.

Upside Risks

At the same time, short-sellers and other bears might get burned as well. The Fed can stop hiking the interest rates. This will have a good effect on the U.S. economy and consumer demand as such. So, companies selling used cars might see rising sales. The same can be true of Carvana. As I have mentioned above, Carvana has been facing improving earnings results for a few quarters. The net losses have decreased somewhat. The trend can continue in the future, making investors rush to buy CVNA stock.

Then, we all know that CVNA stock is highly volatile. This means its price goes up and down by a lot. Even though you might feel that CVNA is an ideal asset to sell short, the stock might surge dramatically overnight if a positive announcement is made.

Conclusion

Carvana Co. stock is neither a good buy nor a good sell. The company is loss-making, it has a low credit rating and a poor financial position, and we do not really know the consequences of the agreed-upon debt exchange. However, the company's quarterly earnings are improving. And we do not know exactly what will happen to the economy. A soft landing might also be a possible scenario. Right now, used car sellers are not going through their best days. But we do not know what will happen to the industry either. So, in my view, both bulls and bears might get burned.

For further details see: