Bad companies can survive when times are good, even if their business models fundamentally don't work. Easy access to capital can keep the lights on, and profits are always just a few years away.
But when the economy turns south and raising cash becomes difficult or impossible, the party can end abruptly. Carvana (CVNA 2.85%) and Wayfair (W -3.72%) made the most of the sky-high demand for used cars and home goods during the pandemic, but the bonanza is now over. Both companies are burning cash and are buried in debt, and neither might make it out of a prolonged recession.
Carvana
The fact that a company known for car "vending machines" is having financial troubles shouldn't be all that surprising. Carvana experienced impressive growth during the pandemic as used cars were in high demand. At its peak, it sold 117,600 vehicles to customers in a single quarter.
Used car prices have since moderated, and consumers are under pressure from rising interest rates and elevated inflation. Carvana's sales have crashed. The company sold just 79,200 vehicles in the first quarter of 2023, down 33% from its quarterly peak.
The biggest problem for Carvana is not this slowdown in sales. Instead, it's the company's debt-ridden balance sheet. Debt totaled $8.5 billion at the end of the first quarter, compared to total cash of about $700 million. That debt required $159 million in interest payments in the first quarter alone. Nearly half of the company's meager gross margin goes to interest.
Carvana's book value, or assets minus liabilities, has turned negative. For an asset-heavy company like this one, that spells trouble. It reported a net loss of $286 million in the first quarter. Reduced costs and a higher gross margin weren't nearly enough.
Management is attempting to restructure its debt, but it's unclear whether that effort will succeed. Creditors would likely need to take losses to make a deal happen. A group of creditors has reportedly proposed a debt-for-equity swap, but nothing has yet been agreed upon.
There's no easy way out of this debt mess. The core business is struggling, and the company has never managed to turn a profit, even during its pandemic boom. Carvana is less than worthless, according to its balance sheet. A recession could be the final nail in the coffin.
Wayfair
Online furniture retailer Wayfair expects to generate positive adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) in the second quarter. Unfortunately, this "achievement" won't stop cash from flying out the door.
The sky-high demand of the early pandemic period has given way to a much tougher environment for Wayfair. Revenue was down 7.3% year over year in the first quarter, and the number of active customers plunged by 14.6%.
The company has made some progress cutting costs, but it hasn't been nearly enough. Its net loss was $355 million in the first quarter, and free cash flow was negative $234 million. Despite what management says, Wayfair isn't even in the ballpark of producing a real profit.
One big problem is the lack of any discernable competitive advantage. Almost everything you can buy on Wayfair can be bought elsewhere. For a consumer, there's no benefit buying from Wayfair over buying from Amazon, or from any other retailer for that matter. Price is the only lever Wayfair has to pull, a situation that does not generally lead to hefty profits.
Its balance sheet is a little frightening. Here's how book value, or assets minus liabilities, has evolved over time:
W book value (quarterly) data by YCharts.
Wayfair is an asset-light company that doesn't keep any meaningful inventory on hand, so a negative book value isn't necessarily a problem. McDonald's, for example, operates with a negative book value since it franchises most of its locations. But McDonald's is highly profitable and has a valuable brand. Wayfair is not and does not. Total debt was $3.1 billion at the end of the first quarter, compared to about $1 billion in cash.
Wayfair announced a $600 million convertible debt offering on May 8, which would plump up the balance sheet a bit. But that would only cover less than three quarters of free-cash-flow losses based on the company's first-quarter results. If a recession strikes, knocking down demand further, Wayfair could have trouble making it through to the other side.
