Last year was a difficult one for the stock market in general, but even more so for growth tech stocks in particular. Carvana (CVNA 6.23%), a fast-growing and disruptive online used-car retailer, is one such enterprise that wishes 2022 had never happened. It's facing some serious challenges right now, and the stock was down a whopping 98% last year.
While the shares continue to bounce around quite a bit, Carvana's current market capitalization is about $1.2 billion. I think the company still possesses huge upside. The issue, however, is that there is one big red flag.
A true disruptor
The traditional way that used cars are sold in the U.S. is a process many hate. Prospective customers must not only choose from a limited selection of cars on the lot, but they also have to haggle with salespeople for better pricing and financing terms. I haven't even mentioned how long the entire process can take.
Enter Carvana. It built its business to improve upon the inconveniences of the brick-and-mortar model. Carvana offers a massive inventory of used cars that is available to any customer nationwide. Prices are meant to be attractive, with frictionless financing options available. Most importantly, customers can buy or sell their cars from their phone or computer in as little as 10 minutes. To be frank, Carvana's solution is necessary in an outdated and disliked industry.
Before macro headwinds completely rattled the industry in 2022, Carvana was able to increase sales from $130 million in 2015 to $12.8 billion in 2021; units sold skyrocketed by 65-fold during that same six-year stretch. Think about that for a second. This isn't some software-as-a-service start-up. This is a used car e-commerce business. That is ridiculous growth.
One of the most attractive characteristics about investing in Carvana is just how enormous the domestic used-car market is. To use round numbers, there are usually 40 million units sold per year, with sales in the ballpark of $1 trillion. And according to Carvana, the largest industry player only commanded 2.2% of the entire market in 2020. It's an extremely fragmented playing field, leaving the opportunity ripe for Carvana to expand.
Carvana sold 438,000 retail units over the past four quarters, giving the business a tiny market share of 1.1%. If Carvana can get to 1 million annual units sold nationwide, or just 2.5% of the U.S. market, at some point within the next five years, its annual revenue could hit $25 billion. That market share is conservative. In Atlanta, Georgia, the company's most mature market, Carvana reported 3.5% penetration in terms of number of units sold in the fourth quarter of 2021, with 95% of the company's markets ramping up faster than Atlanta at the same age.
Achieving the management team's long-term target EBITDA (earnings before interest, taxes, depreciation, and amortization) margin of 13.5% would be a real possibility. The market cap in this scenario would easily be multiples of Carvana's current value.
The elephant in the room
Despite having what appears to be unbelievable upside thanks to its better user experience, wide selection, attractive pricing, and potential to continue stealing market share in a massive industry, there is one major red flag with Carvana's business right now. And that's its financial situation.
Carvana's financial troubles have been well-publicized as the business deals with possible bankruptcy or some other restructuring thanks to macro headwinds that have hurt the used-car market. Higher interest rates in 2022 are not only forcing many experts to predict a recession this year, but they have hurt sales of used cars. With a vehicle inventory balance of $2.6 billion (as of Sept. 30) that is depreciating with each passing day, Carvana is in a tough spot.
The company's problems can certainly be blamed on the external economic environment, but management had some hiccups as well that made things worse. Carvana bears quickly point to the company's $2.2 billion acquisition of used-car wholesaler ADESA in May of last year. This move was meant to strengthen Carvana's competitive position in the industry, but it came at a huge cost.
To fund the deal, Carvana raised $3.3 billion worth of bonds in April 2022 that had an eye-watering interest rate of 10.25%. Currently, the balance sheet contains $6.6 billion in long-term debt, compared to just $316 million of cash. Carvana's largest creditors have also signed an agreement to work together in case any major restructuring does end up happening.
There's no doubt that Carvana's market opportunity is gigantic. However, the company's survival is in question right now. Only bold investors who are willing to take on the added risk and accept the heightened uncertainty should consider buying the stock.
