During the early days of the COVID-19 pandemic, used car dealer Carvana (CVNA -3.65%) was a market rock star. Automobile manufacturers' supply chains were broken. But with the echoes of 2019's economic strength still ringing at the same time interest rates were near multidecade lows, demand for used cars remained robust. From their early-2020 low to their late-2021 peak, Carvana share prices rallied more than 1,200% on the company's brisk growth.
In retrospect, it's clear that none of the underpinnings for that huge return were built to last. The stock gave back all of its gains, logging a new record low in December.
It would be easy to assume a rebound-prompted bullish swing from this stock is in the cards. Shares could bounce back at some point. But the used car company's business isn't apt to recover soon enough to justify starting a new position just yet. There are three key reasons why.
1. U.S. used car sales dropped 10.8% in 2022
On the surface the company's operation looks simple and predictable enough: Carvana buys used cars and resells them at a reasonable markup. Although no industry is immune to cyclical headwinds, the number of used cars sold by U.S. dealers, as well as individual owners in any given year is pretty close to the prior year's figure.
As it turns out, however, used cars are far more sensitive to the economic and logistics (read "supply") backdrop than you might ever suspect. Cox Automotive reports that the 36.2 million used cars sold in the U.S. in 2022 are the lowest number of deals since 2013. The 4.35 million unit drop from 2021's peak level of 40.6 million is also one of the biggest year-over-year drops on recent record.
A combination of rising new car inventories and falling new car prices get the bulk of the blame. Edmunds says U.S. buyers of certain new vehicles are finally able to buy them below the vehicle's sticker price again, suggesting dealers know they've got to be at least a little competitive. At the same time, Kelley Blue Book reports that while December's average new car price of $49,507 is yet another record, some pricing in certain cases is falling. Moreover, researchers with JPMorgan Chase estimate new car prices will fall on the order of 2.5% to 5% this year as inventory eases back toward pre-pandemic levels.
Image source: Getty Images.
2. The supply of used cars also dropped significantly
It's not just the availability of more and cheaper new cars working against Carvana right now, though. The supply of used cars it sells the most of is also drying up.
See, vehicle leases dropped quite a bit in the throes of the pandemic, falling from around one-third of all new vehicle deals to less than 20% now, according to Cox Automotive. Now with fewer leased cars being turned back in for resell, the supply of one- to three-year-old cars (the ones iSeeCars says account for about half of Carvana's sales) is lower.
On the surface it seems bullish for the prices of this particular sliver of used cars. Scant supply and healthy demand pushes prices upward, after all. To this end, car-shopping app CoPilot says December's average used car price is still more than $7,000 above what would be considered "normal."
The average sales price doesn't necessarily correlate with the sheer number of used cars being sold, however. Carvana may continue to sell 1- to 3-year-old cars at a respectable price; it's just set to sell fewer of them in the foreseeable future. Auto insurance savings app Jerry estimates used car dealers will process 31% fewer off-lease vehicles this year than they did in pre-COVID 2019.
3. Interest rates pushed the price of used cars too high
Last but not least, even if used car prices start to stabilize or at least level off, they're still effectively out of reach for many consumers. Credit reporting company Experian says as of December, the average monthly payment for a used vehicle in the United States stands at a hefty $525. That's more than the average new car payment from just a few years back.
Yes, sky-high prices are a factor, and falling used car prices could help on this front. They may not help much, though. That's because much of this payment increase simply reflects higher interest rates on used car loans. Kelley Blue Book reports the average interest rate on used car loans currently stands at a whopping 12.9% versus a year-ago comparison of 9.4%.
In light of this additional cost, many consumers may be highly motivated to shop around for much cheaper used vehicles that Carvana typically doesn't keep in its inventory.
More risk than most investors need to take on
It's not the end of the world for Carvana. As noted above, the used vehicle market is usually more consistent than the new car business. All three of the stumbling blocks described above are also temporary. Consumers will eventually start leasing cars at historical rates again, and the lack of supply keeping new car prices relatively high will eventually be resolved.
None of this relief is likely to materialize in a meaningful way anytime this year, however, leaving Carvana stock vulnerable to the industry's current headaches. Indeed, the company was briefly, barely profitable in early 2021, but quickly slipped back into the red -- deeply -- in the meantime. Carvana's liquidity could become a serious issue in the near future. We just don't know.
There's one thing we do know for sure at this time: Carvana stock currently poses too much risk for most investors to mess with.
