Carvana (CVNA 8.79%) has a new plan. That's a good thing, because the old one has left the company bleeding red ink, taking one-time write offs, and encumbered with debt. The stock has fallen roughly 95% from its 52-week high as investors have clearly begun to worry that the used car dealer is charting an unsustainable course.
With management shifting gears, is it time to buy? Or better to watch from the sidelines for progress on the company's self-imposed milestones?
There are big risks here
At this point, Carvana is only an appropriate investment for the most aggressive of investors. The problems here are many. For example, it has yet to achieve full-year profitability, with the loss in 2022 expanding to $15.74 per share from red ink of $1.63 it had in 2021. To be fair, a goodwill impairment accounted for a good portion of the loss in 2022, but that in and of itself is a huge statement.
Image source: Getty Images.
Essentially, the used car dealer believes the value of its brand has been tarnished so badly that it wrote down the value of its goodwill by $847 million. Goodwill is an accounting figure that places a value on a company's brand and other intangibles. It is also where the cost above the value of the assets of an acquisition gets placed.
But that's not the only admission of trouble here.
As a relatively young company, Carvana has been focused on growth, which is not surprising. It has been willing to lose money as it grows, which is also fairly normal. But events in 2022 led to "a significant shift in our priorities away from growth and toward profitability." Reading into that just a little, what the company was doing up until 2022 was increasingly unsustainable, and Wall Street finally noticed.
Carvana is trying to get onto a better path, which is good, but the process is only just beginning. That is why all but the most aggressive investors will want to watch from the sidelines here.
The things to watch
To management's credit, it has laid out some broad goals. That's a wonderful thing for investors, because they have a yardstick to which they can hold the leadership team. Simply put, don't buy the stock if these goals are missed. Perhaps take a second look if management can live up to its self-imposed mile markers.
Here are some key things to watch over the next year:
- The company wants to complete an annualized SG&A reduction of over $1 billion compared to the first quarter of 2022 by the second quarter of 2023.
- Gross profit per unit (GPU) is expected to have troughed in the fourth quarter of 2022, with future quarters showing improvement back toward GPU of $4,000.
- The company should move toward positive adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization).
While these are reasonable goals, it's important to remember that there are still headwinds here. For example, the cost reduction efforts have required the company to cut advertising spending. That, as you might expect, will likely make it harder to attract customers to the brand.
Also, the company only entered five new markets in 2022 and has no major plans to expand its reach in 2023. This comes after roughly seven years of very rapid expansion, suggesting that future expansion opportunities might not be all that compelling. That doesn't mean that the markets it serves are insufficient to produce a strongly profitable company, but investors may need to adjust their long-term expectations now that Carvana is capable of serving around 80% of the U.S. population.
And the company's debt load rose dramatically in 2022 (more than doubling year over year) because of an acquisition, which led to a material increase in interest expense (this figure nearly tripled year over year in the fourth quarter). Money-losing companies with material debt on their balance sheets often find themselves in a race against time.
Carvana is hoping to improve profitability so that it can cover its interest costs, but that isn't likely to happen right away. So more debt could show up before this issue is fully resolved, which would further increase financial risk.
Wait and see
Carvana competitor CarMax is proof that selling used cars can be a large and profitable business. Investors provided Carvana a lot of leeway as it was growing, but in 2022 Wall Street clearly shifted toward a "show me" stance. To its credit, the used car dealer has pivoted and created goals that investors can monitor.
With so much red ink, though, most investors will likely be best off tracking the company's progress toward those goals rather than jumping in right away. If management can live up to its own expectations, perhaps it's worth reconsidering Carvana's stock. If it falls short, well, there's likely to be more pain ahead for the stock.
