It wasn't very long ago that online used car retailer Carvana (CVNA 0.29%) was looking as though it was heading off to the junkyard to be sold for scrap. A lack of inventory, soaring used car prices, and rising interest rates conspired to run the industry off the road and for Carvana's stock to spontaneously combust.
Shares fell an astounding 94% in 2022, and bankruptcy was on everyone's lips. This year it's a different story. That stock has rocketed 183% year to date as meme stock traders embraced the seemingly dying company, even more so than with other supposed dead and dying stocks like AMC Entertainment (up 67% in 2023) and Bed Bath & Beyond (133% higher).
Has Carvana pulled itself out of the ditch at last, or is it just careening to the cliff on the other side of the road? Let's take a look at where the online used car operation will be one year from now, as three or five years down the road might be too far off into the future for this admittedly ailing jalopy.
Image source: Getty Images.
A new way to drive used car sales
Carvana wanted to upend and modernize the used-car-buying experience by streamlining how consumers buy vehicles. At the end of the third quarter, Carvana was in 315 markets, had 18 inspection and reconditioning centers reaching over 81% of the U.S. population, and had 33 car vending machine locations.
It is certainly an appealing model. No salespeople, no haggling. You surf its inventory of around 70,000 vehicles, choose the one you want, and Carvana will even complete financing and paperwork for you online before delivering the car to your door. The spectacle of watching your car being delivered to you from its automated parking garage at its vending locations is also an option if you live near one.
And yet the business is imploding. Carvana is heavily indebted as it sought to roll up the market under its umbrella. A year ago, it acquired Kar Global's Adesa U.S. auction subsidiary for $2.2 billion in cash, doubling its long-term debt from $1.6 billion in 2020 to $3.2 billion in 2021 and then doubling again to over $6.6 billion at the end of the third quarter.
That sequence of events has given Carvana a debt-to-equity ratio that is 9 times greater than rival CarMax, 27 to 3.3, while AutoNation is doing even better at 1.5 and Cars.com has just a 1.3 debt-to-equity ratio.
Skidding out of control
To help contain spiraling costs that exceed its sales, management has cut marketing expenses and vehicle acquisition costs and has been firing employees. It laid off 20% of its workforce in 2022 and then laid off even more last month.
Although it's important to reduce expenses to get a handle on them, Carvana hasn't reached a critical mass yet where it can just coast on word of mouth. And a lack of inventory is an issue as it reduces the probability a car buyer will find a match, reducing potential sales.
After hitting record highs last year, used car prices are starting to fall, down 8.8% from the year-ago period. Yet they remain significantly above where they should be. Car buying assistant CoPilot estimates used car prices remain over 30% above where they should be and are carrying a $7,100 premium.
Yet falling prices aren't necessarily a panacea for Carvana because it is stocked with vehicles that were acquired at higher prices. It might have to take a loss on the cars it sells, or at the minimum reduce its per-vehicle profitability, which will make it difficult for Carvana to be a profitable operation.
In December, a group of creditors holding the majority of Carvana's debt joined together to negotiate with the company as its interest expense tripled year over year to $333 million in the third quarter. Wall Street believes a debt restructuring will leave the stock worthless if it declares bankruptcy.
Image source: Getty Images.
Heading for the junkyard
So why is Carvana's stock soaring? Those meme stock traders mentioned earlier have been rallying around the stock just as they did to those broken businesses in early 2021, but with the online used car dealer scheduled to report fourth-quarter results later this month, the likelihood of another crash grows large.
Other stocks like GameStop and AMC used the opportunity of a boost in their share prices to raise capital. The video game retailer was also frequently mentioned as a bankruptcy candidate but used the proceeds from its elevated share price to pay off all its debt. AMC took a less sound strategy and is still walking a thin line.
The jury is out on where Carvana will end up, but the prospects don't look good at the moment. A lot may be determined after its next earnings report, but while Carvana's business concept was a great one, the execution doesn't seem to have been on par. I expect we'll find Carvana still around one year from now but limping along in the breakdown lane.
