2023-03-22 17:13:09 ET
Summary
- Even at EBITDA breakeven, the company will still burn a lot of cash given its high interest expense.
- Meanwhile, the used car market remains difficult.
- I think bankruptcy is still a very real possibility in the next few years.
While Carvana ( CVNA ) has some runway to continue to try to get its house in order, I think the most likely scenario still points to bankruptcy.
Company Profile
CVNA is an online used car dealer. Through its e-commerce platform, consumers can buy, sell, or trade-in used cars. On the purchasing side, the company's platform allows consumers to search for vehicles that meet their criteria and provides a 360-degree view of the vehicles with close-ups of any flaws, such as a scratch. Buyers can have cars delivered to them, or they can pick them up at one of the company's car vending machines.
Customers can also sell their vehicles online to CVNA by answering a few online questions without needing to provide photos or service records. The company will give customers an offer, which if accepted, the customer can then schedule a pick-up time and receive payment.
CVNA has a network of inspection and reconditioning centers across the country that once it acquires a vehicle, it inspects and then brings each vehicle that goes onto its site up to its standard. The company primarily acquires vehicles through its customers, as well as at auctions and places like rental car companies. Last year, it bought car auction company ADESA for $2.2 billion.
The company also makes money through financing, as well as offering vehicle service contracts (VSCs) and Gap insurance. VSCs are serviced under DriveTime, which is a psychical used car dealership owned by the company's largest shareholder.
On the financing side, CVNA often securitizes its receivables and sells them to partners. It retains at least a 5% interest in the credit risk of the underlying finance receivables. It has a Master Purchase and Sale Agreement (MPSA) with Ally ( ALLY ) where CVNA doesn't have recourse for the receivables post-sale performance. It sold $3.8 billion in principal balances of finance receivables under the MPSA and $2.4 billion in principal balances of finance receivables through other securitization transactions in 2022, per its 10-K.
Risks and Opportunities
CVNA's biggest risk is bankruptcy. The company is perhaps the poster child for a growth-at-any-cost mentality, as it tried to scale its concept as quickly as possible. This resulted in huge cash outflows even as revenue rose, as well as a lot of debt on its balance sheet.
With rising interest rates, used car pricing volatility, and increasing subprime auto delinquencies, CVNA faces a lot of headwinds it likely will not be able to overcome. A large portion of CVNA's GPU (gross profit per vehicle) comes from selling auto receivables (part of other GPU), and this market is showing signs of stress with higher delinquencies.
According to Cox Automotive , 1.89% of auto loans were considered severely delinquent in January, the highest level since it started tracking the number in 2006. The delinquency rate for loans 60 or more days was up 20% from a year ago, while defaults were up over 33%. Meanwhile, 7.3% of subprime auto loans were delinquent in January, the highest they have ever been dating back to 2006.
Other data points are just as dire. Repossessions are also climbing , and in late February , subprime auto lender American Car Center announced it was ceasing all operations.
For its part, CVNA does not break out what percentage of its loans are subprime and hasn't directly answered the question when asked. However, a few years ago in 2019 at a Citigroup Conference, CEO Ernie Garcia said that "our average FICO is very similar to the average FICO of used car buyers, and our distribution looks very similar to the broader distribution."
Still, greater delinquencies will cause risk spreads to widen, which either will lessen what it earns, or CVNA will have to pass that on to the consumer, which then can hurt sales, or have consumers seek out 3rd-party financing.
When you combine that with higher interest rates, it leads to much higher payments, which can cause this downward spiral of then increasing delinquencies, as payments are getting higher due to both rates and risk spreads. At this point, we haven't even hit a recession, so this dynamic of increased auto delinquencies could get a lot worse in the future.
Another big negative for CVNA has been volatile used car prices. Prices were very strongly going up last year, which is great for used car dealers, as inflation and a lack of new car inventory due to past supply constraints helped drive used car pricing. However, towards the end of 2022, prices started to decline quickly, which led to dealers such as CVNA having bought inventory at too high of prices.
For 2023, wholesale prices have started to come back up. However, retail prices have not, which according to CarDealershipGuy on Twitter , is leading to dealers with recently acquired inventory being over book value that they now have to sell at a loss and try to make up on the backend through things like VSCs and extended warranties.
The big question for CVNA is, can it survive these difficult times, when it had already been hemorrhaging cash when times were good for used auto dealers. For their part, CVNA's bondholders don't seem to think it will make it through this period. In December , a group of bondholders signed a pact to act together in negotiations with the company. The group, led by Apollo and Pimco, owns about $4 billion in unsecured debt, or about 70% of the total. BlackRock, Ares, and Knighthead are also part of the group. The agreement is to avoid infighting as the group looks to secure more favorable terms in case of a bankruptcy.
Apollo stepped in to save CVNA last April when it purchased $1.6 billion in bonds to help the company close its deal to acquire ADESA when other firms balked at participating in the debt issuance. However, it was at a very high rate at the time and on very favorable terms to Apollo.
For its part, CVNA says it has $3.9 billion in liquidity, which includes its $434 million in cash on the balance sheet, $1.4 billion in availability under its revolver, and $2 billion in unencumbered real estate. The company is also trying to reduce costs, talking about lowering SG&A by $100 million in aggregate in the first half of 2023.
The biggest risk to the short case is that CVNA can survive this rough spot and get back to growing profitably. The company has scale and has shown it can generate positive EBITDA in the past. Meanwhile, it is looking to cut costs, which should help get it back closer to EBITDA positive.
Even if the company eventually gets back to EBITDA breakeven, however, it still has about $600 million in interest expenses and another $100 million in CapEx, so $700 million in cash burn. But it will be difficult to get to EBITDA breakeven in this environment, so I think it's likely to burn at least $1 billion in cash. Add money to the revolver at today's high rates, and the interest expense and cash burn just go up more. Sales leasebacks of car vending machines likely won't happen, and other real estate deals (like for ADESA's real estate) likely won't be on favorable terms given the situation CVNA finds itself.
Conclusion
CVNA has some runway to survive if the economy cooperates, but even if it does, I think it will largely be a debt-burdened zombie company that will not be able to generate enough cash to pay debt down to a reasonable level. As such, the most likely case scenario remains that the company will eventually go bankrupt within the next few years, in my opinion, especially if we hit a recession. Given that, I think the economy is likely headed in that direction and free cash flow is likely to remain elusive even if the company can turn EBITDA positive.
Inevitably, though, the stock will also likely see some large rallies at some point given its short interest. You've already seen this happen despite the continued overall downward trend in the name. Nonetheless, this is a name I'd avoid.
For further details see:
Carvana: Bankruptcy Is Still A Very Real Possibility