Deal-hungry investors are likely watching Carvana (CVNA -0.36%) closely. Trading for just $8.90 at the time of writing, shares have fallen by a whopping 94% over the last 12 months. But a low price doesn't always mean a good value. Let's discuss three reasons why the embattled online dealership could get even cheaper over the long term.
Macroeconomic conditions are worsening
Founded in 2012, Carvana is a used-car dealership that aims to disrupt the industry with an e-commerce business model, in part by using aggressive marketing gimmicks such as car vending machines in major U.S. cities. Historically, the company enjoyed a respectable growth rate before growth really soared during the stay-at-home period at the height of the COVID-19 pandemic.
Now, Carvana is giving back ground as macroeconomic conditions tighten in the automotive industry.
Image source: Getty Images.
Americans are buying fewer cars as problems like inflation eat into family budgets, and rising interest rates increase the financing costs of these often big-ticket expenditures. These challenges may get worse before they get better. According to analysts at market research firm Cox Automotive, used-car values fell by 14% in 2022 and could drop by an additional 4% in 2023.
The industry weakness reduces the number of used cars Carvana can sell and the margins of its business.
Carvana's balance sheet is a mess
Carvana's fourth-quarter earnings results highlight the severity of its challenges. Revenue tanked by 24% year over year to $2.8 billion as the number of vehicles it sold fell 23% to 86,977 units. The company's net loss ballooned to $1.4 billion, and it is unclear how much longer these losses are sustainable because of its highly leveraged balance sheet.
At the end of 2022, it had just $434 million in cash and equivalents compared to a whopping $6.6 billion in long-term debt.
To deal with debt repayment and interest expenses, Carvana may have to take on additional debt to kick the can down the road or issue additional shares. But this isn't free money. Equity dilution reduces current investors' claim on future earnings or cash flow.
A third option would be selling off valuable assets like real estate to raise capital, which may be the ideal solution for a declining company that might not need as much real estate (such as car testing centers) to conduct its operations.
The valuation is not as cheap as it looks
While bankruptcy is a possibility for Carvana, the company may use asset sales, debt refinancing, and new share issuance to limp along until used-car industry conditions improve. And with a market capitalization of just $1.1 billion, the stock looks super cheap compared to its full-year 2022 sales of $13.6 billion.
But when you buy a stock, you buy more than just a portion of its revenue. You also get its debt. When factoring in net debt, Carvana's enterprise value jumps to $8.8 billion, giving it a substantially less affordable-looking valuation. Furthermore, the company's huge losses could lead to additional debt accumulation or shareholder equity dilution.
Investors should stay far away from Carvana until the company's operational issues are resolved. The pressures show no signs of easing anytime soon.
