Carvana (CVNA 2.85%) made a big mistake when it slammed the growth accelerator during the pandemic years; total debt quadrupled in just a few years to $8.3 billion. The Federal Open Market Committee's aggressive shift in interest rate policy tightened the lending environment last year, and now Carvana's scrambling as investors demand profitability from their stocks.
But you can't escape debt unless you pay it off or go bankrupt, so Carvana is between a rock and a hard place. The stock's 98% decline from its high is a loud statement about the market's skepticism toward Carvana.
Unfortunately, Carvana's recent attempts to restructure its debt might not matter. Here are three reasons to avoid the stock altogether.
1. $8.3 billion in debt, with more ahead
Carvana sells used vehicles. These are expensive items, so the company borrows money to buy inventory, paying it back as it sells. But you can see below how its operating cash flow is negative, meaning Carvana is losing money from running its day-to-day business. And that doesn't include other expenses, such as interest on its debt. So Carvana has steadily borrowed more money over time.
Management leaned into growth over the past few years, pumping up marketing and buying and selling more vehicles. Carvana went from selling 50,000 to 60,000 units per quarter in 2020 to more than 100,000 in 2021 and early 2022. The company's debt grew faster as a result:
CVNA Cash from Operations (Quarterly) data by YCharts
But now Carvana's in quite a hole. Interest expenses alone were $486 million over the past year, which is more than it has in cash on the balance sheet today. The company will need more funds to pay interest moving forward, which doesn't even include any future operating losses. Unfortunately, debt will probably continue piling up.
2. There's nothing left for shareholders
Just how bad have Carvana's financials gotten? The company's balance sheet is officially turned on its head; Carvana's shareholders have negative $1.05 billion in equity in the company as of Q4. What does this mean? If you liquidate the business, Carvana's total assets wouldn't be enough to pay all its liabilities. In other words, there's nothing left for investors.
Management hasn't waved the white flag; it highlighted various sources of additional liquidity, such as short-term committed credit and unpledged real estate assets, which total about $3.4 billion. But tapping this reserve isn't ideal, because it includes assets it already spent to acquire, such as $1.1 billion of real estate belonging to the auction business it acquired, ADESA.
Additionally, it recently announced efforts to restructure its debt. If successful, it would kick the can down the road, buying Carvana time to turn its financials around before its bills come due. But it's hard to see that as anything more than a temporary band-aid without the business at least running profitably.
The other option would be an equity raise, issuing shares to raise money. But the stock is nearly worthless; the dilution (new shares decrease the value of existing shares) from a raise would be massive. There's no clear path to a good outcome here besides Carvana becoming a profitable business.
3. Macro headwinds go against cost-cutting efforts
Management is frantically cutting budgets to stop the bleeding. For example, it's targeting $100 million in savings by cutting selling, general & administrative costs over the next two quarters. Management wants to achieve break-even non-GAAP EBITDA first and then generate positive free cash flow. But again, there's not much time to turn the ship.
The economic environment threatens to offset management's cost-cutting efforts. Analysis from JPMorgan calls for a 10% drop in used vehicle prices in 2023, which could pressure Carvana's profit margins -- something it can't afford now. The company's Q4 results included a 63% year-over-year decrease in total gross profit and a 51% drop in profit per vehicle. Higher interest rates and declining vehicle prices mean the next several quarters could be similarly bad.
Carvana is a cool idea; I don't doubt that it can offer customers a better vehicle-buying experience. However, that doesn't make it a sound business. There wasn't much margin for error because of how competitive vehicle sales are and how capital-intense the company is (vehicles cost thousands of dollars). Add in management's missteps with the balance sheet, and here we are. Investors should steer clear of this financial wreck.
