Why investors have jumped the Carvana bandwagon

Ernie Garcia, CEO of Carvana

Scott Mullin | NBC Finance

DETROIT – Last year, Kavan CEO and co-founder Ernie Garcia took the win.

He touted the company’s “landmark” second-quarter results in August. May 2021, which includes the used car retailer’s first-quarter net profit. He then recalled how “a group of ambitious kids with an incredible amount of learning” quickly grew into a Fortune 500 company.

It’s now clear that the company’s executives have more to learn. Amid rising interest rates, inflation and self-harm, Carvana’s fairytale rise has become an investor’s nightmare.

Since Garcia’s comments last year, the company’s shares have fallen 98% from an all-time high of nearly $377 a share set last August to $6.50 a share this week. Carvana’s market cap plummeted from $60 billion to $2.2 billion after a modest rally that ended the week.

The stock rose more than 30% on Thursday and 19% on Friday to $11.88 a share on the back of a broader market rally and a possible short selling squeeze.

But bad news and financial results have continued since the stock peaked, raising concerns among investors about the company’s long-term trajectory. It also has little cash on hand, with $6.3 billion in debt, including $5.7 billion in senior notes.

Carvana CEO Ernie Garcia on company's first profitable quarter

Carvana has been borrowing money to cover its losses and growth plans, including the $2.2 billion all-cash acquisition of ADESA’s U.S. physical auction business earlier this year. Carl Global.

“We think CVNA is far from out of the woods as we won’t see a V-shaped recovery even if the industry bottoms out,” JPMorgan analyst Rajat Gupta wrote in a note to investors on Tuesday. The firm cut its rating on companies Earnings and free cash flow forecasts.

Morgan Stanley downgraded the stock’s rating and price target last week. Analyst Adam Jonas cited the deteriorating used car market and the changing financing environment.

management mistakes

Carvana has grown exponentially during the coronavirus pandemic, as shoppers turn to online purchases instead of visiting dealerships, and promises to easily sell and buy used cars in customers’ homes.

But Carvana doesn’t have enough vehicles to meet the surge in consumer demand, nor enough facilities and staff to handle its inventory. Slowing demand due to rising interest rates and recession fears has led Carvana to buy ADESAs and a record number of vehicles at sky-high prices.

“We’re building more than just showing up,” Garcia said on an April 20 earnings call, with the stock down 37% the following week.

In its first-quarter earnings report, the company was criticized for spending too much on marketing, including a bland 30-second Super Bowl ad, and failing to prepare for a potential slowdown or decline in sales.

debt

Then there’s Carvana’s debt.

The company’s bonds hit record lows this week as it burns through cash and faces rising borrowing costs.

The Wall Street Journal reported Wednesday that the company’s long-term bonds have fallen to worrying levels, some of which are now as low as 33 cents in dollars. As of Tuesday, its 10.25% note was yielding more than 30%, according to MarketAxess, a sign that Carvana is currently struggling to borrow from the bond market.

Morgan Stanley cited the company’s debt and uncertain funding outlook in pulling down the stock’s rating and price target. Jonas said the “deterioration of the used car market and volatility in the interest rate/funding environment” poses “significant risks” to the company.

Jonas issued a new base case range for Carvana of $1 to $40 per share over the next 12 months.

pricing pressure

The used car market will end the year down more than 12% from the 40.6 million used cars sold in 2021, according to a mid-October estimate from Cox Automotive. Carvana’s sales through the third quarter of this year were up 4% from 2021, but profits were much lower than a year earlier and were down sequentially.

Carvana’s third-quarter sales fell 8% year over year, while profit per vehicle sold plunged 25% to $3,500. CEO Garcia described the end of the third quarter as “the most unbearable time ever” for customers buying cars.

“Carvana has successfully disrupted the automotive industry with a proven e-commerce model serving millions of satisfied customers, and while the current environment and market has attracted recent attention, we continued to gain market share in the third quarter and we remain focused on Our plans drive profitability while providing a better car buying and selling experience,” a company spokesperson said in a statement.

Used car prices down 2.4% since last month

The decline was due to lower wholesale prices for new cars. The Mannheim Used Car Value Index, which tracks the prices of used cars sold at U.S. wholesale auctions, fell 15.4 percent this year through October after peaking in January, including a 2.2 percent decline in September-October.

Retail prices have traditionally followed changes in wholesale prices. That’s great news for potential car buyers, but not great news for companies like Carvana that bought these vehicles at record prices and are now trying to sell them at a profit.

Used car prices have held steady so far, but that may not last long as wholesale costs continue to fall.

“They don’t want to sell at rock-bottom prices,” said Chris Frey, senior industry insights manager at Cox Automotive. “That’s why we haven’t seen retail prices drop that much.”

affordability

Frey noted that car affordability continues to decline, with auto loan rates hitting their highest level in 15 years, albeit with a slight decline in prices. The average used listing price for used cars is stabilizing, but remains near an all-time high of more than $28,200, according to Cox Automotive.

“We’ve seen the impact of a slowdown in retail sales, and a lot of it has to do with affordability,” Frey said. “The affordability aspect combined with these higher prices is starting to have an impact on sell-through rates.”

The race is also catching up with Carvana.During the coronavirus pandemic, franchise car dealers such as automation Forced to start selling vehicles online, while showrooms are closed and consumers stay away from dealerships. Carvana’s traditional competitors are starting to deliver on the same promise of worry-free online car buying.

“They took a lot, almost all of the air out of the balloon for Kavanagh,” Frey said.

— Michael Bloom of CNBC contributed to this report.

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