Carvana (CVNA 5.85%) was going to revolutionize the used car market by shifting it online. That hasn't actually worked out quite as well as planned, however, and the stock is now down over 95% from its peak in 2021. While the first quarter of 2023 showed some improvement in financial performance, the company's heavy debt load means there's a ticking clock that can't be ignored.
A glass half full/half empty
If you tend to be a positive person, Carvana's first-quarter 2023 earnings were pretty good. For starters, the headline on the earnings release was "CARVANA REPORTS BEST FIRST QUARTER IN COMPANY HISTORY FOR ADJUSTED EBITDA AND TOTAL GROSS PROFIT PER UNIT" (emphasis in the original). That sounds great and is backed up by the company's highlights of "Net loss margin was (11%), an improvement of 3.5% compared to first quarter 2022" and "Adjusted EBITDA margin was (0.9)%, an improvement of 9.4% compared to fourth quarter 2022, resulting in the best first quarter in company history."
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Further, the "[c]ompany expects to achieve positive adjusted EBITDA in second quarter 2023." And Carvana actually beat Wall Street expectations on both the top and bottom lines. But how positive is all of this, really?
As far as analyst consensus estimates, the company's revenue was higher than projected but down 25% year over year on a 25% decline in the number of cars it sold. At the bottom of the income statement, the loss was less than expected but still a painful $1.51 per share. What's interesting is that the loss of $1.51 per share doesn't show up in the news release about earnings -- you have to go to the company's shareholder letter to find that figure. Clearly, companies want to put a positive spin on quarterly results, but that kind of feels like a vital omission.
And even the positive comparisons provided (such as an improved "net loss margin") were all just less-bad numbers, not good ones. Sure, you can say the company is moving in the right direction, but there's a not-so-subtle catch that is highlighted by management's comments about achieving positive adjusted EBITDA in the second quarter.
Carvana's debt problem
EBITDA stands for earnings before interest, taxes, depreciation, and amortization. It's an interesting metric because some of those items (depreciation and amortization) are non-cash in nature and don't really impact cash flow. But interest and taxes are expenses that have to be paid and can materially impact cash flow. For Carvana, interest expense is a big problem given the $6.5 billion of long-term debt sitting on the balance sheet.
Interest expense increased from $64 million in the first quarter of 2022 to $159 million in the first quarter of 2023. Not only is that a massive jump, but interest expense alone ate up around 46% of the used auto dealer's gross profit. That's a huge headwind, especially when you add in the $472 million in selling, general, & administrative expenses that helped to push the company deep into the red in the quarter. Getting to positive adjusted EBITDA is fine, but there's a lot more here for investors to worry about than EBITDA.
In fact, the company knows it has a serious debt problem because it has been trying to do a debt exchange. But its lenders have been less than receptive to the offer, which would require them to take a haircut on the value of their current bonds. Carvana has sweetened the offer and extended the deadline multiple times, which suggests it is desperate to get a deal done. The lenders, meanwhile, are rumored to have countered with a deal that would trade debt for equity, among other things. With $500 million in debt maturing in 2025, followed by even larger maturities in 2027, 2028, and 2029, it's likely that Carvana is starting to get a little desperate for a deal, and it may have to accept some terms it doesn't really like.
The problem is that, over the next five years, Carvana, a company with a shrinking business that is bleeding red ink, has to find a way to roll over debt, or -- well, that's the thing that investors need to consider quite carefully. If Carvana can't fix the debt problem soon and in a way that provides it with material financial breathing room, it could very well find itself in bankruptcy court. Achieving positive adjusted EBITDA probably won't be enough to change that.
There's a pattern
The path toward bankruptcy is fairly well worn. Two of the biggest signs on the road are poor operating performance and a heavy debt load. Even though Carvana may be moving in the right direction, it still has a very real risk of not existing, at least not as it does today, in five years. In fact, investors should probably be paying more attention to the balance sheet than the income statement today, as the ability to deal with upcoming debt maturities will likely be a bigger predictor of the company's future than its ability to achieve positive adjusted EBITDA.
