Carvana (CVNA 2.88%) was in the right place at the right time, allowing customers to buy used cars online at a point in history when people were stuck at home. That's a story that helped to drive a lot of online-focused companies during 2020 and the early days of the coronavirus pandemic.
In 2023, however, the story doesn't seem quite as good, with Carvana's stock down over 95% from 2021's peak. Here are three key signs of how bad the company's struggles are.
1. A heavy weight
One of the things that Carvana has been doing is buying competitors, even ones that operate primarily in the physical world. This obviously costs money. Then there's the not so subtle fact that buying used cars to resell is a fairly expensive proposition. Cars are big-ticket items, even at the low end of the auto market. Carvana has had to put up a significant amount of capital up front to support its business.
Image source: Getty Images.
While that's clearly a simplified view of complex decisions and actions, what's not very complex to see is that Carvana's balance sheet has become highly leveraged. Carvana's debt-to-equity ratio sits at a huge 27 multiple. For reference, used car giant CarMax (KMX -0.91%) has a debt-to-equity ratio of around 3 To add fuel to the fire, Carvana isn't profitable and has never been so for any full year of its existence.
A highly profitable company with a lot of leverage may be able to muddle through fairly well. A highly leveraged company that is losing money often becomes a very big problem.
CVNA Debt to Equity Ratio data by YCharts
2. Pulling back on growth
In the used auto retailer's third-quarter 2022 shareholder letter, management stated that the company had reduced advertising spending by 11% year over year and inventory by 10%. Both were efforts at saving money and make complete sense given the situation the company is in today. But there was an interesting nuance.
According to management, a key piece of the advertising pullback was, "less advertising in distant markets with less profitable sales." Step back and think about that for a moment. It means that the company had historically grown in these markets even though they weren't all that attractive. It was growth for growth's sake and not necessarily growth to improve profitability. And yet investors need to remember that Carvana is not profitable, so growing the top line faster without benefiting the bottom line seems like a potentially risky approach.
With that backdrop, it's no wonder that Carvana is shifting its focus to concentrate on its best markets. That's a logical move, but with so much leverage there's a risk that this shift may be too little too late.
3. More cost-cutting
Trimming advertising and inventory are clearly cost-cutting moves, but they aren't the only ones the company is making. It is also working on reducing its selling, general, and administrative expenses. In fact, it dedicated an entire section of the third-quarter 2022 shareholder letter to the effort. There was a table, with eight specific line items, showing that management had achieved a 15% reduction in costs compared to the second quarter of 2022.
That was followed by a table that listed each area in which the company was focused on cost-cutting and what it had so far achieved. Very clearly, Carvana wants Wall Street to know it is serious about trimming fat and it wants to show that it is acting quickly. That's not bad, per se, but the speed of the effort suggests that time is, perhaps, not a luxury that the company can afford.
Tread with caution
Carvana has an interesting business model, but that alone won't make it a long-term success story. In 2020 and into 2021, growth investors were enamored by the disruptor story as the retailer took on more traditional used auto sellers. That growth story has quickly stalled and, with so much leverage, it looks increasingly like Carvana has hit the wall. Most investors should probably rethink the prospects here.
