What happened
Shares of online used car marketplace Carvana (CVNA 0.29%) soared as much as 38% this week, according to data from S&P Global Market Intelligence. The company got a credit upgrade on its auto loan securitizations and launched a new national advertising campaign. Investors likely took these as positive signs for the company, one that looked to be at major risk of bankruptcy to start 2023. As of this writing, shares of Carvana are up 33% this week and an astonishing 240% year to date.
So what
Carvana's business model is buying and selling used cars on its marketplace, facilitating transactions between consumers and wholesale purchasers. When someone buys a car from Carvana, it will originate an automotive loan for them (as you likely know, the majority of car purchases are funded with debt). However, instead of keeping these loans on its balance sheet, Carvana packages up its loans and sells them to third-party financiers.
There have been rumblings in recent quarters about the credit quality of the loan securitizations, which caused S&P Global to downgrade its credit ratings. Underperforming loans wouldn't immediately impact Carvana, but they have the potential to ruin its relationship with its financing partners, an important piece of its business model.
Apparently, these worries have been overblown, with Carvana announcing this week that S&P Global raised its credit ratings on 21 classes of Carvana loan securitizations and maintained its rating on 19 other classes, meaning that the loans are performing better than previously expected. This is great news for the automotive market and Carvana, as it looks like its business model is in a better place than people thought earlier this year.
On top of this, Carvana announced a national advertising campaign to try to get more consumers to spend on the Carvana platform. Earlier this year Carvana was tightening its belt and looked to be running into liquidity issues. While not a direct statement saying its liquidity concerns have dissipated, struggling companies typically don't launch expensive advertising campaigns. This news could have been taken by investors that Carvana is back to playing offense instead of on the defensive.
Now what
A turnaround for Carvana could be in the cards, but the company still has a lot of progress to make. The company has burned over $1 billion in free cash flow over the last 12 months; that metric will need to get into positive territory quickly, or else Carvana will likely burn through all the cash on its balance sheet. These two news items this week indicate things are moving in the right direction, but investors should be looking for material changes to its income statement in the coming quarters as evidence the financial improvements are finally here.
