There is a very large market for used cars. And there is a very large market for fitness equipment. But that isn't enough to make either Carvana (CVNA 5.85%) or Peloton Interactive (PTON 2.62%) successful companies. In fact, right now, there's a very real question about whether they can survive as companies at all. Here's what you need to know about these two once-hot stocks.
Things get ugly
Carvana and Peloton were both perfectly situated to benefit from the coronavirus pandemic. When people were asked to practice social distancing and to work from home, buying a car completely online and working out "together" from home via an internet-connected exercise bike were hot ideas. Not only did customers like them, but investors really liked them. In 2020, the stock of used car dealer Carvana soared 160% while exercise equipment maker Peloton saw its shares rocket over 430%.
Image source: Getty Image.
Those ascents peaked in 2021 and now both stocks have plunged around 95% from their respective high-water marks. There are varying reasons for this, but there's one similarity between the two companies that shouldn't be ignored. They each have a material level of debt that needs to be addressed.
In the case of Carvana, where buying inventory is a very expensive but necessary proposition, long-term debt has increased over 380% over the past five years. Yes, that helped to fuel its expansion, but the company continues to lose money and bondholders will eventually want to be paid back. The debt expansion at Peloton isn't quite as bad, but it doesn't have to buy expensive items to then resell. Its long-term debt increased by over 100%, but just in 2022 alone. It, too, is a money-losing business.
Nuances matter
Clearly, the debt that these two companies have on their balance sheets is important. But there are big differences in what that debt looks like. Peloton is the easier of the two to get a handle on. It has around $1 billion worth of zero-coupon convertible bonds due in 2026. The conversion price is so far above the current stock price that it is highly likely it will need to pay back that debt.
However, with a zero interest rate, the financial impact is minimal. The real issue is that 2026 is approaching. The company needs to turn its business around before that point or things are going to become very difficult.
Carvana's debt is larger and more spread out. While the total amount at $5.6 billion is way higher, it comes in tranches. There's $500 million in 2025 that needs to be repaid followed by $600 million in each of 2027 and 2028, and then $750 million in 2029. So it has a little more time before it needs to come up with cash, but then there's a multi-year period where it will need to refinance a lot of debt.
Meanwhile, the debt here carries interest rates between 4.875% (2029 vintage) and 5.875% (the 2028 notes). The company isn't currently covering its interest expenses. It, too, needs to turn things around in a big way.
Which outlook is better? If you are a conservative investor, you should probably avoid both Peloton and Carvana since it would be better to position that question as which outlook is less grim.
The answer is probably Peloton, given the slightly longer time it has until it has to repay its debt and the zero interest rate on those convertible notes. But it's only appropriate if you are a turnaround-focused investor and, of course, you believe the company has a real shot at turning itself around.
Carvana is working with lenders in an effort to deal with the debt it has piled up, but its lenders appear to be less than receptive to the idea.
Suddenly, it matters a lot
Investors often overlook balance sheets, especially for fast-growing companies since the focus is on expansion -- and this requires spending money that often comes from debt sales. The expectation is that the company will turn profitable before the debt bill comes due. But in the case of Peloton and Carvana, with time running out, their balance sheets are starting to matter in a bigger and bigger way. Neither company is for the faint of heart, but it looks like Peloton may have a little more breathing room to maneuver -- for now.
