Shares of Carvana (CVNA -2.10%) were surging by almost 25% in after-hours trading on Thursday after the online used-car dealer reported significant progress in its cost-cutting initiatives.
Carvana stock plunged last year, as fears of a bankruptcy torpedoed the stock as sales growth slowed and losses mounted. However, the company pledged to cut costs and streamline the business, and it seems to have done just that.
Economics of the business improve significantly
Revenue in the first quarter fell 25% to $2.61 billion, which edged out estimates of $2.60 billion, but that revenue decline was by design as the company scaled back advertising and other spending and shifted its focus from growth to profitability.
Gross profit per unit (GPU), a key metric, jumped 52% to $4,303, and total gross profit increased 14% to $341 million.
That shows that even as revenue fell, the income metric that really matters -- gross profit -- still grew. Total GPU benefited by $643 per retail unit sold in inventory allowance adjustments as it took a reserve charge in the fourth quarter of 2022 for aging inventory, though it was still up substantially adjusting for that.
On the selling, general, and administrative line, the company also made significant progress, reducing non-GAAP (generally accepted accounting principles) SG&A expense from $649 million in the second quarter of 2022 to $404 million in Q1 2023, resulting in $245 million in SG&A savings.
As a result, adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) loss narrowed from $348 million in the quarter a year ago to $24 million.
Its free-cash-flow loss also narrowed substantially from $813 million to just $98 million. Excluding a discrepancy between the inflow and outflow of finance receivables, the company would have been cash-flow positive.
As you can see from the chart below, most of the key profitability metrics are moving in the right direction.
Image source: The Motley Fool.
There are several reasons to believe that Carvana is back on a path to recovery and bankruptcy is off the table. Let's take a look at three of them.
1. Management is executing its profitability plan
Management spelled out a simple profitability plan earlier in its turnaround.
1. Drive the business to positive adjusted EBITDA.
2. Drive the business to significant positive unit economics.
3. After completing steps one and two, return to growth.
Adjusted EBITDA margin in the first quarter was just negative 0.9%, and the company expects to deliver positive adjusted EBITDA in the second quarter.
Its cost-cutting measures also show that the company has more control over its profitability than bears may have thought. It's reduced the amount of time it holds vehicles, pulled back on marketing spending, announced multiple rounds of layoffs, and focused on efficiencies like incentivizing customers to pick up cars at its vending machines or vehicle reconditioning centers and charging for long-distance deliveries.
Those are lasting changes that should continue to benefit the bottom line even once the company shifts its focus to growth again.
2. Liquidity is solid
The risk of bankruptcy seems to be the primary reason that the stock crashed last year. The company's acquisition of the ADESA wholesale auction business proved to be ill-timed as it was precisely when used car prices were falling and interest rates were rising.
However, the first-quarter results should reassure investors that the company has the liquidity to survive the current crunch. It finished the quarter with $488 million in cash and equivalents, a slight improvement from $434 million in Q4 2022, and it has $1.5 billion in committed liquidity resources, including $1 billion in untapped short-term revolving credit facilities. Factoring in $2 billion in unpledged real estate, the company has $3.5 billion in total liquidity available.
With its free-cash-flow loss narrowing to less than $100 million in the first quarter, that liquidity should give the company a sufficient cushion to effectively remove the risk of bankruptcy, barring a significant change in the macro environment.
3. The macro headwinds are fading
Rapidly rising interest rates last year caused used car prices to fall and raised the cost of Carvana's own variable-rate debt.
However, the Federal Reserve has basically said it's done raising interest rates after Wednesday's 25-basis-point hike, and, according to the Manheim used vehicle value index, used car prices are rising again in 2023 after falling by 15% in 2022, though they did fall from March to April this year.
Falling used car prices were a significant problem for Carvana last year as it meant that the billions worth of auto inventory it holds was losing value. However, rising used car prices are a benefit for the company, and even stabilization would be a significant improvement after last year. That and the end of interest rate hikes should support the company's recovery.
Carvana still has a lot of work to do to return to financial health, especially as it has more than $6.5 billion in debt on its balance sheet, but that risk seems to be sufficiently priced into the stock with the share price still under $10 and its market cap at just $1.3 billion.
This is still a high-risk stock, but the upside potential is considerable if it continues making progress on its recovery plan.
