Carvana (CVNA 0.56%) has been a battleground stock in recent years, with many vocal bulls and bears either singing the praises of the online used-car marketplace or calling out its shortcomings. In 2020 and early 2021, it looked like the bulls were proved right as share prices soared over 1,000% in just a few years. But then, in late 2021 and 2022, the bears were vindicated as shares cratered more than 98% to under $5 by the end of 2022.
Owning (or shorting) Carvana shares has been a roller coaster ride and this is not a stock for the investor looking for stress-free choices with low volatility. In 2023, the stock has managed to jump 127% so far, but it's still down 97% from its highs set in 2021.
Given the nice jump in 2023, is Carvana stock ready to make a comeback? Or is this just another bubble company with an unsustainable business model that will eventually be worth zero?
Carvana's Q1 earnings: More cash burn
The first quarter of 2023 wasn't great for Carvana, but the company did show some progress in getting to profitability. Revenue declined 25% year over year in the period to $2.6 billion, but gross profit actually increased 14% to $341 million as the company was able to earn a better margin on each vehicle sold through its online used-car marketplace.
This helped Carvana's quarterly operating loss improve from $506 million in 2022 to $288 million in the first three months of 2023. While still unprofitable, the stock jumped after the company released these financial results in early May, indicating that investors were expecting a higher operating loss in the period.
The biggest problem for Carvana has always been cash flow. Not once since going public has the company generated positive free cash flow, burning $1.12 billion over the last 12 months. Some bulls might argue that free-cash burn has been greatly reduced compared to prior years, which is true, but there is still lots of progress to be made before the company achieves a stable financial position.
If its revenue keeps declining, it is hard to see how the company can get there despite its recent improvements in gross margins. Management is guiding for improved margins in the second quarter due to expense reductions, but retail units sold are still forecast to decline from 2022.
CVNA free cash flow data by YCharts.
More pain in used car prices
As a used car marketplace, Carvana buys vehicles and then sells them to the highest bidder (either a wholesale or retail customer). This means the company needs to keep inventory on its balance sheet between the time it buys and sells the car, exposing it to depreciation and overall changes in average used car prices.
During the pandemic, Carvana greatly benefited from supply shortages that drove up the average price of used cars. At the peak, prices were up more than 50% on average compared to before the supply chain disruptions. This helped it earn a better profit margin on vehicles sold through its marketplace as sometimes it was able to sell a used car for more than it bought it for, which is unusual in the automotive industry.
Source: Manheim Used Vehicle Index. Note: January 1997 = 100.
Then, in 2022, used car prices started to decline with supply chain issues easing, leading to Carvana's cash flow and overall profitability taking a hit. Prices have recovered a bit to start 2023, which helped its margins in the first quarter.
However, leading automotive lender and large Carvana partner Ally Financial projects used car prices will decline by more than 15% by the end of 2023, which you can already start to see happening in the chart above. That means that Carvana will once again go from a macroeconomic tailwind (used car prices rising) to a macroeconomic headwind (used car prices falling) for the rest of the year.
Call me crazy, but this doesn't sound like a great economic environment for Carvana to try to reach positive cash flow.
Can Carvana survive?
With the stock soaring over 150% this year, many investors seem to think the likelihood is rising that Carvana survives its liquidity issues, regains its prior growth trajectory, and starts generating positive cash flow. I have my doubts that this will remain a viable business in its current form, though.
Let's consider the company's balance sheet and liquidity issues, for example. At the end of the first quarter, Carvana had $488 million in cash on its balance sheet, $1.7 billion in short-term debt, and $6.55 billion in long-term debt. Just in the first quarter, it had to pay $160 million in net interest expense on this debt, and it is unlikely the company will be able to raise even more debt since it already has so much on its balance sheet, is not growing its revenue, and is unprofitable.
If the company keeps burning cash, it will run out of money this year and will likely be forced to enter bankruptcy or raise money through a stock offering, both of which are bad news for shareholders.
Second, it is tough to see Carvana start growing again since it has pulled back aggressively on marketing spend to try to improve its profit margins.
And third, it is unlikely that cash flow is going to flip to positive over a trailing-12-month period (the company might squeak out positive cash flow for a quarter or two) due to the projected declines in used car prices. Not a great situation to be in.
Carvana never had a profitable business model, and unless its unit economics drastically change within the next few quarters, it never will. The company is likely going to run out of cash or heavily dilute existing shareholders within the next few quarters, making the stock one to avoid for investors right now. There are plenty of other, better-run businesses to invest your savings in instead.
