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Why Carvana's Stock Has Rocketed 68% Higher in Two Days on Its New Financing Deal

By Asit Sharma - Mar 25, 2020 at 4:35PM

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The digital car sales innovator gets a shot in the arm at an opportune moment.

Shares of online car-buying and selling platform Carvana (CVNA 26.11%) surged 43% on Tuesday after it announced a financing deal with Ally Financial (ALLY 1.02%). Known for its hassle-free buying experience and glass tower auto vending machines, Carvana saw its stock soar another 25% in late-afternoon trading on Wednesday. Financing agreements typically don't spur such an ascent, but Carvana's stock had plunged 61% year to date prior to the deal. In addition, these aren't normal times. Let's delve into the reasons this announcement has kindled such a fire under the stock.

A welcome boost to liquidity

Ally Financial is one of the largest providers of automotive finance in the country, and it offers Carvana receivables financing under a master agreement that's renewed each year. What, exactly, is receivables financing? When Carvana provides a car buyer with an auto loan, the total amount to be received over the life of the loan is listed on Carvana's books as an auto loan receivable. Carvana sells a significant portion of these receivables to Ally. Investors should note that, in addition, Carvana packages up some of its receivables into bundles and sells these bundles to third parties through a process called securitization.

Carvana's latest one-year agreement commits Ally to the purchase of up to $2 billion in finance receivables, effectively doubling the car seller's existing available limit. This is important because next to its "floor plan facility" (i.e., a revolving credit line that helps the company purchase car inventory), selling customers' auto loans is a critical source of Carvana's liquidity

An electronic key fob up close.

Image source: Getty Images.

This type of asset-based financing is advantageous for both parties. Carvana can sell car loans to realize its cash profits up front, thus focusing on its core platform strengths rather than acting as a long-term lender. Ally purchases the loans, presumably at a slight discount, then collects principal payments plus interest and any fees -- thus playing to its own core strength as a financing specialist.

The current climate should theoretically benefit Carvana's operations. According to Reuters, which this week cited projections by Moody's Analytics, automobile sales could decline by as much as 20% in 2020 due to the COVID-19 pandemic. Yet Roadster, which provides digital sales support services to car dealerships, has seen online traffic rise by 6%. Clearly, Carvana's position as the most comprehensive online car-buying platform can serve as a competitive advantage during this time of coronavirus-induced shutdowns.

Until yesterday, though, investors were concerned over potential liquidity issues the company might face during an extended economic downturn. These concerns have now evaporated, as the company will enjoy immediate access to working capital as long as it continues to sell vehicles.

Stable -- or rising -- business during a downturn?

The vote of confidence from a major lending partner isn't the only reason Carvana's stock has turned so deeply green over the last two sessions. In its brief press release announcing the new master financing deal, Carvana noted that this latest iteration will "broaden the set of customers covered by the agreement."

In other words, Ally will relax some of the underwriting criteria required by the financing agreement to enable Carvana to close loans with slightly less creditworthy customers, and/or those who may be facing financial difficulties due to the coronavirus outbreak. According to founder and CEO Ernie Garcia, "This commitment from Ally puts Carvana in a strong position to provide our customers fair, simple financing in this time when so many need it."

Reading the tea leaves, Carvana will be less constrained in closing new car loans thanks to the flexibility provided by Ally. This could translate into relative sales stability during 2020. The organization won't report on earnings again until May, although it may follow many other companies in reducing or suspending its fiscal 2020 guidance beforehand. Carvana's pre-coronavirus outlook called for revenue expansion of 42%-47% in fiscal 2020. While it's safe to assume that management will trim this range in the near future, car stock investors appear to believe that, however small, Carvana's top-line growth may still be positive this year.  

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Stocks Mentioned

Carvana Stock Quote
Carvana
CVNA
$27.58 (26.11%) $5.71
Moody's Corporation Stock Quote
Moody's Corporation
MCO
$280.05 (1.87%) $5.14
Ally Financial Stock Quote
Ally Financial
ALLY
$34.55 (1.02%) $0.35

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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