Carvana's (CVNA 5.85%) stock price has fallen more than 90% over the past year. It has shifted away from its growth-at-any-cost model to one directed at getting the company to turn a profit. While management wants investors to focus on that effort, very few seem to be discussing the company's heavy debt load. It has to be watched closely.
Getting bigger
When Carvana entered the used-car sales space, it was looking to bring the internet into a market that had long been entrenched in the physical world. It started off small, as you might expect, selling just 2,100 or so cars in 2014 across three markets. But it scaled up very quickly, selling more than 412,000 cars in 316 markets in 2022. Revenue rose from $42 million to $13.6 billion over the span.
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The problem is that revenue is not earnings. If a company is willing to lose money, it can usually grow revenue at an aggressive pace. Notably, Carvana lost $15.74 per share in 2022. To be fair, that includes a sizable goodwill impairment, which is a one-time item, in the fourth quarter driven by the massive decline in the company's stock price. But the truth is, Carvana has never turned a profit because it has been so keenly focused on growing the business.
There was a change in direction in 2022, but by that point, the company's growth efforts had left it with $6.5 billion in long-term debt on its balance sheet, more than double the level at the end of 2021. And few on Wall Street seem to care enough about the company's debt to ask about it.
One question
During the company's fourth-quarter conference call, just a single analyst asked about debt, describing it as the "elephant in the room." The company basically dismissed the question, suggesting that it had room to take on more debt if it wanted. A key part of that response, meanwhile, was the belief that Carvana would be able to start making money.
That's a big "if" that will require a lot of hard work. It may be possible, but thanks to the debt the company has taken on, it had $153 million in interest costs in the fourth quarter, up from $55 million in the same stanza of 2021. That's nearly triple the cost. And given that gross profit was $193 million, it doesn't leave much room for the more than $600 million in selling, general, and administrative expenses on the income statement. In fairness, the company has more than $600 million in cash on the balance sheet, but its operating activities ate up roughly $1.3 billion worth of cash, and the ending cash balance was supported by debt and equity issuances.
With the stock having fallen so hard, issuing stock would not be a desirable move, given the massive shareholder dilution it would probably cause. On the debt front, meanwhile, the company is currently trying to persuade its lenders to exchange current debt for longer-term dated new debt. It's looking for lenders to reduce the principle in exchange for a higher interest rate and shifting the debt from unsecured to secured. But also included is a request for the ability to pay in kind for up to three years. That basically means that instead of interest, Carvana will just increase its debt by the interest amount. These aren't things a company on sound financial footing looks to do, and there's no guarantee that lenders will be willing to go along.
If Carvana doesn't get its lenders to agree to this debt exchange deal, it has $500 million worth of debt coming due in 2025. That's a material debt cliff and, at least at present, it probably doesn't have the balance sheet to pay that off and fund its ongoing business.
Don't ignore the obvious
Carvana is not on solid financial ground. Yes, it does need to focus on turning profitable, which investors should be monitoring. But the balance sheet is at least an equally important issue, and the fact that only one analyst brought up the question on the conference call is a sign that perhaps not enough people are watching this very notable risk. If you own or are looking at Carvana, make sure you pay attention to the risk the company's heavy debt load poses.
