Carvana (CVNA -0.36%) is one of the highest-profile victims of the past year's tech bear market. Investors have dumped the unprofitable growth stock as they flock to safety in the face of high inflation, rising interest rates, and a weakening economy.
Consequently, the online automotive retailer has lost close to 99% of its value. Some investors may be wondering whether Carvana has become a bargain opportunity, but upon closer inspection, management's missteps have made this stock a non-starter -- here's why.
The Carvana model
Carvana burst onto the scene with a vision to change the way consumers buy used cars. Instead of dealing with the salesperson at a dealership, customers can browse Carvana's large inventory and buy their vehicle through an online, no-haggle transaction. Purchases, trade-ins, and financing all take place on the same platform.
In 34 of its markets, buyers can even pick up their vehicle from a Carvana vending machine. Customers insert a token, watch the car come out of the machine, and go on their way.
This business model initially won over both car buyers and investors alike, especially when the pandemic increased the appeal of online shopping and contactless transactions. Supply chain issues also decreased the availability of new vehicles, driving up demand (and pricing) for used cars. Carvana saw its business surge higher as a result.
What went wrong
Unfortunately for Carvana shareholders, the company's finances are now in a dire state.
If one wants the simplest explanation of Carvana's downfall, the company valued growth at any cost. In the third-quarter 2022 shareholder letter, management admitted to incorporating the value of future sales into pricing decisions. That led to making sales that carried lower profit margins.
When the market was experiencing a severe used-car shortage, especially in 2021, Carvana could afford to make those lower-margin sales. It still managed to increase its gross profit per unit 40% that year and expanded its net margin by over six percentage points to negative 2.2%, approaching break-even.
However, as interest rates rapidly rose in 2022 and high inflation began taking its toll on consumer demand for used cars, gross profit per unit plummeted and continues to do so. Combined with declining sales volumes, the pressure on Carvana's profitability is clear with its net margin hitting negative 15% in the third quarter. And as the bear market took hold with investors becoming far less tolerant of money-losing companies, Carvana's stock is down over 95% in the past year.
To make matters worse, Carvana put further pressure on its business last year after acquiring ADESA's U.S. physical auction business in 2022 at a cost of $2.2 billion. That contributed heavily to the company's current financial woes as its debt load now exceeds $7.4 billion.
As of Sept. 30, Carvana held only $316 million in cash and equivalents, leading many investors to question how it will service its debt, let alone acquire the funding it needs to execute its turnaround plan. With a depressed stock price, issuing shares is probably not an option. And despite implementing cost-cutting measures throughout last year, third-quarter selling, general, and administrative expenses made up 19.4% of revenue, nearly triple the management's long-term target of 7% (at the midpoint).
Is there any hope?
Given its dire financial picture, Carvana is just too risky an investment at this point. With little cash and few prospects to raise additional funding, the company appears to have run out of options. Management's previous strategy to value growth at all costs may eventually doom this former market favorite.
