What happened
Shares of used-car dealer Carvana (CVNA 6.07%) dropped 38.5% in December, according to data provided by S&P Global Market Intelligence. The entirety of the drop came in the month's early days, after troubling reports surfaced regarding the company's liquidity. And this issue remains unresolved going into 2023.
So what
According to reports from Bloomberg, Carvana's management is getting legal advice about how to handle its debt. Its debt load stood at about $6.8 billion as of the end of its third quarter of 2022. Its lenders are also reportedly meeting together to figure out what they're going to do about Carvana.
Few analysts remain bullish about Carvana stock. But these reports caused one of the last ones to downgrade their outlook. According to The Fly, William Blair analyst Sharon Zackfia believes Carvana stock will now only perform inline with the market average, as opposed to her previous stance that Carvana stock would be a market-beater.
After losing one of the last bullish analysts, investor confidence is running extremely thin on Carvana stock right now. Indeed, down 99% now from its all-time high, the stock trades at a level that suggests many believe it could need to be restructured in the future.
Now what
Not to stoke fears, but Carvana is in a difficult position entering 2023. First, its debt load is high, and that's becoming a bigger deal pretty quickly. For example, consider that in Q3, it had $153 million in interest expense -- more than triple what it was in the same quarter of 2021. For perspective, that was about 43% of its gross profit, which is high.
Moreover, Carvana took on a substantial portion of its debt recently to acquire wholesale used-car dealer ADESA. In theory, this acquisition was a great idea -- Carvana needs inventory to grow its business, and acquiring this major player turbocharges that. However, the deal was ill-timed in retrospect.
Used-car values were historically high in 2021 and 2022, and Carvana was rapidly scaling inventory during this period. However, used-car values are now starting to fall. And consumers are slowing purchases because interest rates are on the rise.
In other words, Carvana used debt to acquire inventory, which is standard for this kind of business. However, much of its inventory was acquired at inflated prices, and it's now struggling to sell, which is why its liquidity is becoming a concern among analysts and its lenders.
Turning back to analysts, Zackfia believes Carvana has enough money to make it through 2023. But she admits this outlook assumes an end to rising interest rates and a better economic environment for consumers. That outlook may be rosy and further underscores the mountain Carvana is climbing.
For now, I don't personally see a compelling reason to buy Carvana even at these levels. But it may indeed develop plans that will give it enough time to solve for the problems it's facing. That's certainly management's perspective. As it said in its letter to shareholders, "Our goal is to be made better by the challenges we face."
