Whether you believe in Carvana's (CVNA 2.88%) potential or think it's doomed, most investors are aware it has a serious cash burn problem and that its growth has come to a crashing halt. However, it has an equally big problem some overlook: its soaring interest expense.
Let's explain Carvana's interest expense problem and compare it to rival CarMax (KMX -0.91%), which has more than twice the debt but a small fraction of the interest expense concern.
Interest expense vs. cash
Let's first look at a graph that emphasizes not only how quickly Carvana's interest expense has soared but compares it to cash and cash equivalents and also shows why it's worse than it looks.
CVNA Cash and Equivalents (Quarterly) data by YCharts.
Here's the kicker -- when Carvana issued its latest round of senior 2030 notes at a 10.25% interest rate, the terms were to pay it bi-annually, with the first payment due last November. That means 2023 will be the first year its largest interest payments are felt in full and will likely push its full-year interest expense to nearly $600 million.
While management has slammed the brakes on growth and is attempting to reverse its cash burn, it's not a stretch to say much of the company's cash could soon be dedicated to interest expense alone.
Let's take it a step further and compare Carvana's situation with its closest competitor, CarMax.
Not all debt is created equal
Buckle up your seatbelt here; it gets a little tricky to navigate, but it'll be worth learning how the competitors face such different situations.
Let's take a look at CarMax's total long-term debt compared to its interest expense. As CarMax has over twice the amount of long-term debt that Carvana does, you might expect the former to have a larger interest expense problem, right? Not quite.
KMX Total Long Term Debt (Annual) data by YCharts.
The above graph isn't an error; CarMax's interest expense doesn't register. Here's where we have to dig deeper and really understand Carvana and CarMax's debt. Excuse the jumble of numbers in the next two tables -- we'll fully explain them, but take a glance first and see if you notice differences.
The first is a look at Carvana's debt table.
Image source: Carvana's 10-K SEC filing.
And now, here's a look at CarMax's table.
Image source: CarMax's 10-K SEC filing.
There are a lot of numbers to digest there, but let's focus on the big issues.
First, you'll notice with Carvana that the bulk of its total debt in that table is at a staggering 10.25% interest rate. You'll also notice that the rest of its notes are still slightly higher than Carmax's senior notes.
Further, the remaining part of Carvana's roughly $8 billion in debt is found under its total asset-based financing. These are loans related to the purcahse of vehicles and the vehicle is collateral against the loan. These types of loans are generally more manageable, less expensive, and far less of an issue than its senior notes, so let's keep the focus on the latter.
Zooming in on CarMax's table, its revolving credit facility doesn't note the interest in the table, but in the 10-K details, it states the weighted average interest rate was 1.97%.
Next, CarMax's term loans had an interest rate of 1.01% as of Feb. 28, 2022, and as no repayments are scheduled to be made within the next 12 months, they aren't showing on graphs of interest expense.
The just-mentioned two debt chunks are at much lower interest rates, but the elephant in the room is the $15.5 billion in non-recourse notes payable.
Non-recourse notes payable is not included in interest expense because it is reflected within CarMax Auto Finance income.
Essentially, when CarMax helps customers finance their vehicles, it does so profitably, and it generates income off that massive debt pile by dishing it out to consumers at a slightly higher interest rate. That's making a complex process as simple as possible, but you get the idea.
To sum things up, a majority of Carvana's total debt is unsecured notes at higher interest rates, compared to CarMax's majority of the total debt that actually generates income -- CarMax Auto Finance income generated $802 million in 2022. So you quickly understand why Carvana's interest expense is a serious problem, while CarMax's interest hardly registers.
You're probably wondering why Carvana doesn't have a system like that. Well, they do, somewhat. Carvana has a partnership with Ally Financial, and the latter has previously agreed to buy chunks of those loans to generate income, and in turn, Carvana receives instant cash relief to support its business near-term.
The bottom line
Yes, Carvana is in a dire situation and needs to quickly reduce cash burn and focus on profitable growth. It also has a debt pile that is sending its interest expense soaring at a time its cash pile is dwindling.
A comparison to its closest competitor in the automotive industry, CarMax, shows just how large Carvana's debt and interest expense issue is even when CarMax has over twice the total debt.
And that's why investors should understand, keep an eye on, and perhaps worry about Carvana's rising interest expense number.
