Carvana (CVNA 0.29%) and Upstart (UPST -1.97%) both initially dazzled investors with their disruptive dreams. Carvana, which is best known for its "car vending machine" towers, challenged traditional used car dealerships with an e-commerce platform that enabled customers to easily secure financing, buy vehicles, and sell them online. Its non-negotiable prices eliminated the need to deal with salespeople, and it streamlined the entire financing process with quick online approvals.
Upstart challenged traditional credit reporting agencies by analyzing non-traditional data like a person's education, GPA, standardized test scores, and work history to help banks, credit unions, and auto dealerships approve loans. That approach enabled lenders to serve a much broader range of customers with limited credit histories.
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Both stocks skyrocketed to all-time highs during the buying frenzy in growth stocks last year. Carvana hit an all-time high of $370.10 last August, while Upstart closed at a record high of $390 last October. But as of this writing, Carvana trades at less than $5 while Upstart hovers at around $17. Should investors buy either of these burned-out hypergrowth stocks?
What happened to Carvana?
Carvana's revenue soared 101% in 2019, increased 42% in 2020 even as the pandemic spread, and surged another 129% as most of those headwinds dissipated. It remained resilient throughout the pandemic because it could easily facilitate online orders, as well as touchless vehicle pickups and deliveries.
In 2020, Carvana benefited from the temporary closures of brick-and-mortar dealerships. In 2021, its accelerating growth was largely driven by soaring used car prices, which hit record highs as pent-up demand coincided with component shortages. As a result, Carvana's gross margin rose by a percentage point year over year to 15% in 2021 and it narrowed its net loss.
Unfortunately, it couldn't withstand the inflationary headwinds, rising interest rates, and declining used car prices over the past year. Rampant inflation prevented consumers from making big-ticket purchases, higher interest rates made it tougher to secure financing, and declining vehicle prices reduced its gross margin to just 10% in the first nine months of 2022.
Carvana's revenue only rose 19% year over year to $10.77 billion, while its net loss widened from $46 million to $781 million during that period. That's a lot of red ink for a company that ended the third quarter with just $161 million in cash and equivalents along with $6.62 billion in long-term debt. To make matters worse, 10 of Carvana's largest creditors (which held about $4 billion of that debt) recently teamed up in a unified front to force it to either restructure its debt or secure fresh financing -- which indicates that fears of a potential bankruptcy are growing. For now, analysts expect Carvana's revenue to increase 9% for the full year but for it to remain unprofitable for the foreseeable future.
What happened to Upstart?
Upstart's revenue rose 42% in 2020, jumped 264% in 2021 as more lenders accessed its services in a post-pandemic market, but grew just 28% year over year to $695.5 million in the first nine months of 2022. It expects its revenue to slip 1%-3% for the full year as interest rates continue to rise.
Higher interest rates hurt Upstart in two ways. As we've already seen with Carvana, they prevent consumers from making big-ticket purchases that require a lot of financing. Second, Upstart didn't initially finance its own loans -- it merely approved them for its lending partners and charged transaction fees. However, those partners are now reining in their loans to deal with their own macroeconomic challenges. To address that widening gap, Upstart began funding some of its loans from its own balance sheet earlier this year -- but that daring move significantly increases its own leverage.
That strategic shift might be more palatable if Upstart were profitable. Unfortunately, the company racked up a net loss of $53 million in the first nine months of 2022, compared to a net profit a year earlier, and it was shouldering nearly $1.2 billion in total liabilities at the end of the third quarter. It was still sitting on $830 million in cash and restricted cash, but its liquidity could dry up if rising interest rates continue to throttle its revenue growth.
The valuations and verdict
Carvana's enterprise value of $8.2 billion, which is inflated by its long-term debt, values the company at just 0.6 times next year's sales. Upstart's enterprise value of $1.4 billion values it at 1.8 times next year's sales. Carvana might seem cheaper, but Upstart is the better buy for four simple reasons: its business model is simpler, it isn't completely dependent on the used car market, its balance sheet is much healthier, and its losses aren't as steep. Both companies will likely remain out of favor until inflation cools off and interest rates stabilize, but I believe Upstart will outperform Carvana for the foreseeable future.
