Carvana (CVNA 5.85%) was particularly hard hit by the 2022 bear market, which sent its stock price down by 97% in just 12 months. Unfortunately for investors, the downside looks likely to continue in 2023.
With deteriorating fundamentals and potential debt servicing issues, let's take a closer look at why investors should continue avoiding Carvana stock this year.
1. Carvana's operations are in a tailspin
Carvana is an innovative used car dealership that disrupts the industry through its online-focused business model and flashy branding techniques, such as car vending machines. While the company has been publicly traded since 2017, it really caught Wall Street's attention at the height of the COVID-19 pandemic, when lockdowns and movement restrictions boosted interest in stay-at-home businesses.
Perhaps just as important, the U.S. Federal Reserve kept interest rates low to help cope with the economic disruption. Low rates made it easier for Carvana's customers to obtain affordable credit. As a result, used cars began trading at a healthy premium. However, now Carvana's bull thesis seems to be falling apart at the seams.
Third-quarter revenue declined by 3% to $3.4 billion on the back of an 8% drop in cars sold to $102,570. The top-line deterioration caused net losses to spiral from $68 million to $508 million, even as management expresses its commitment to lowering costs and "driving the business to profitability." Carvana is selling fewer cars for lower prices, and this is a difficult problem to fix because it is largely out of management's control.
2. The macroeconomic environment is grim
Arguably, Carvana's biggest challenge comes from the Federal Reserve, which has reversed its pandemic-era expansionary policy and is now raising interest rates. When interest rates are high, credit becomes more expensive throughout the economy, making it harder for Carvana's customers to take out loans to buy used cars. J.P. Morgan expects these challenges to send used car prices down by 10% to 20% in 2023.
For its part, Carvana hasn't yet provided quantitative guidance for the new year. But investors shouldn't be too hopeful.
Image source: Getty Images.
70% of economists polled by Bloomberg in December expect a recession to occur within the next 12 months. Although an economic downturn could spur the Fed to ease its rate hikes, it would also kill demand for Carvana's business. Used cars are a big-ticket expenditure that people usually delay when money is tight.
3. Carvana may struggle to handle its debts
As of the third quarter, Carvana reports long-term debt of $6.6 billion compared to cash and equivalents of just $316 million. The company generated a net loss of $508 million in the period, and its many headwinds make it unlikely to swing to profitability any time soon. Furthermore, the rising rate environment will increase the coupons on existing bonds, while making them more expensive to refinance.
Carvana's creditors see the writing on the wall and seem to be getting worried. In December, the company's biggest debt holders signed a deal binding them to act together in negotiations. The move suggests they might be concerned about Carvana's ability to meet its debt obligations. And while Carvana may be able to dig itself out of this mess, investors should stay far away from the stock until the long-term picture becomes clearer.
