Carvana (CVNA 0.94%) is reeling after disappointing third-quarter earnings and bearish analyst remarks. Despite its innovative business model, the online used-car dealership faces a triple threat of slowing auto sales, poor finances, and worsening macroeconomic conditions. While shares have fallen 96% year to date, more downside looks likely.

Why is Morgan Stanley turning negative on Carvana?

Managing director of Morgan Stanley's automotive and mobility research team, Adam Jonas, is no stranger to controversial and volatile stocks -- covering the likes of space tourism company Virgin Galactic and electric automakers such as Tesla and Lucid Group.

Historically, Morgan Stanley has been one of Carvana's biggest cheerleaders. In February, the firm assigned Carvana shares a price target of $420 because of its unique e-commerce business model, which Jonas claimed could potentially disrupt more industries than just used cars -- such as commercial fleet management. Now, the analyst sings a more bearish tune.

In November, Adam Jonas pulled his rating on the company and gave its stock a price range of $1 to $40 (with $0.10 being the worst-case scenario), citing a weakening used car market and rising interest rates. Banks expect the federal funds rate (the overnight rate banks charge one another) to hit 5.14% by mid-2023. And this has a spillover effect on the car market by making it harder for consumers to get affordable financing for their purchases.

For an unprofitable company like Carvana, rising rates could also make it more expensive to get the financing needed to operate and expand.

According to Bloomberg data, Carvana's 5.875% and 5.5% notes due in 2028 and 2027, respectively, fell to just 40 cents on the dollar as of Nov. 5, giving an idea of the sort of risk premiums new creditors may demand from the company.

Third-quarter earnings highlight serious problems

Carvana's third-quarter results highlight the severity of its challenges. Revenue fell 3% year over year to $3.39 billion on the back of an alarming 8% decline (to 102,570) in cars sold. This is bad news for what was previously seen as a growth stock, especially considering it might need more scale to become consistently profitable.

Futuristic car speeding through lights.

Image source: Getty Images.

Carvana's net loss ballooned from $68 million to $508 million in the period. And its balance sheet isn't looking too pretty either, with $316 million in cash and equivalents compared to $6.6 billion in long-term debt. The company doesn't look capable of managing its debt through operational cash flow. And since its existing bonds are already deeply discounted, it is unclear whether management will be able to raise new debt (for refinancing) at attractive rates.

Bankruptcy is a real possibility over the long term. And to avert this, Carvana may rely on equity dilution, meaning it may issue and sell additional shares of its common stock. Dilution quickly raises capital, but it's not free money. The process can hurt shareholders by lowering the fundamental value of their stock compared to future earnings and cash flow.

A cheap stock isn't always a good deal

With its epic declines, Carvana stock has likely caught the attention of adventurous investors looking for a deal in the market. But the company should be avoided due to exceptional challenges from rising rates and its poor operational performance.

There is a real possibility of significant future equity dilution and/or bankruptcy. In this case, the analysts seem to be right.