If you invested $1,000 in Carvana (CVNA 4.44%) at the start of 2022, when it was worth $240 per share, you would have just $80 today -- a decline of 92%. And while this may look like a chance to buy a once-expensive company for cheap, investors should look before they leap. Rising interest rates and new car production are squeezing the used car market, and Carvana may struggle to survive these challenges.
What is unique about Carvana?
Carvana went public in 2017 with an initial public offering price of $15 per share. And in the following years, it became a market darling -- soaring more than 2,000% to its all-time high of $370 in August 2021. Investors loved the company's business model, which disrupted the traditional used car dealership business by selling vehicles, accepting trade-ins, and financing purchases exclusively online.
Carvana even features flashy car vending machines as part of its elaborate marketing.
Image source: Getty Images.
Carvana's no-contact model meshed well with the COVID-19 pandemic, which boosted interest in stay-at-home activities. Supply chain issues related to the crisis (such as a semiconductor chip shortage peaking in 2021) also restricted new car manufacturing, benefiting used car dealers like Carvana. Revenue soared by a jaw-dropping 129% year over year to $12.81 billion in 2021. But it was downhill from there.
What went wrong?
For many pandemic-era darlings, the COVID-19-related boost turned out to be a temporary benefit instead of a lasting edge. In Carvana's case, revenue growth is plummeting as the stay-at-home economy fades, new car manufacturing picks up speed, and tightening Federal Reserve policy weakens the macroeconomic environment. The company's second-quarter earnings highlight the severity of these challenges.
Revenue grew just 16% year over year to $3.88 billion, a significant deceleration from the second quarter of last year when it surged 198% over the prior-year period. With the Fed raising interest rates, consumers will find it harder to access credit at favorable rates, potentially reducing demand for used cars. This problem could worsen if the higher rates tip the U.S. economy into a recession because cars are a big-ticket discretionary purchase, often avoided in challenging economic conditions.
Higher rates have also influenced investors' risk-to-reward calculations, causing them to shy away from unprofitable growth stocks like Carvana. The company reported a net loss of $439 million in the second quarter -- a significant decline from the $45 million profit reported in the prior year period. It's hard to see how the company can turn this negative trend around in a worsening macroeconomic environment.
Is there a bright side?
With revenue growth decelerating, profitability collapsing, and many negative macroeconomic trends, investors should avoid Carvana stock. But that doesn't automatically mean the company will always be a bad bet. For now, though, there's more room for the stock to decline.
