Up almost 200% year to date, Carvana (CVNA 2.88%) is one of many beaten-down stocks posting a significant recovery in 2023. But investors shouldn't be tempted by the rally. Carvana's existential challenges remain -- and that includes its cash burn and general weakness in the used car industry.
The company could easily give back all of its recent gains. Let's have a closer look.
What went wrong for Carvana?
Carvana is a used-car dealership that aims to disrupt the industry with its unique online business model. Like many e-commerce-related stocks, it soared amid the stay-at-home boom in 2020 and 2021 before giving back most of its gains in the later-pandemic period. Management's decision to over-expand could take some of the blame. But Carvana faces a much more serious challenge with the tightening macroeconomic environment.
Semiconductor shortages and supply chain constraints in the new car market have eased, eroding demand for their used counterparts. Rising interest rates and inflation hurt the market further by making it more expensive for customers to finance and afford their automobile purchases. According to market research firm Cox Automotive, used car values tanked by 14% in 2022, with an additional 4% drop expected in 2023. This trend has had a disastrous impact on Carvana's business.
Operations are falling apart
Carvana's third-quarter 2022 earnings highlight the crisis. Revenue fell 3% to $3.4 billion after an 8% decline in cars sold (to 102,570 units). And its gross profit per unit dropped by $1,172 to $3,500. Management expects these challenges to continue in the fourth quarter because of the previously mentioned conditions like rising rates and inflation.
In his shareholder letter, CEO Ernest Garcia stresses that "progress is rarely linear," and Carvana is still on the path to becoming "the largest and most profitable automotive retailer," despite its near-term challenges. But while that sounds good, it will be easier said than done.
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Carvana lost $508 million in the third quarter of 2022 alone. And with just $316 million in cash and equivalents on its balance sheet, the company doesn't seem to have much runway left without external financing like debt or equity dilution. Neither is a good option. Equity dilution reduces current investors' claim on possible future earnings, while additional debt will further strain cash flow through repayments and interest expense.
Carvana currently has a whopping $6.6 billion in long-term debt. And the company paid out interest expense of $153 million in the third quarter.
Can the company bounce back?
Carvana's massive rally in 2023 might make investors assume the downside is over. But it's not that simple. Granted, the stock's low market capitalization and heavy short interest (currently 65% of the float) could cause high volatility and explosive near-term gains. But Carvana looks unlikely to maintain value over the long term because of its weak fundamentals. Investors should avoid the stock until the company shows convincing progress toward fixing its problems with slow growth and spiraling losses.
