Shares of online used car retailer Carvana (CVNA 8.79%) are up more than 500% this year. That's not a typo. The heavily shorted stock has made an epic comeback after crashing hard in 2021 and 2022.
While the stock has gained ground, the company itself remains in dire straits. The biggest risk remains exactly the same as it was at the start of the year, and those buying the stock following this rally are unlikely to be happy with the end result.
So much debt
While the stock market is full of speculators and gamblers driving stocks up and down, the bond market is usually a more serious affair. And right now, the bond market is saying that Carvana is a distressed company that's unlikely to survive this decade.
A Carvana bond set to mature in 2030 currently trades at 35 cents on the dollar. In other words, for a bond investor to bet that Carvana will be able to make them whole when this bond matures in 2030, it currently takes a 65% discount to face value.
Even more telling is a Carvana bond that matures less than three months from now that currently trades for 74 cents on the dollar. There's some serious doubt that Carvana will be able to make this payment.
At the end of the first quarter, Carvana had total debt of $8.5 billion, including $6.6 billion in long-term debt, $1.7 billion in short-term revolving debt, and $200 million in long-term debt that's due in the next year. The company spent $159 million on interest, representing nearly half of its gross profit, in the first quarter.
Carvana has debt maturities of at least $500 million in 2025, 2027, 2028, and 2029. The bonds that will mature in those years carry interest rates below 6%. The company will need to refinance those bonds as they near maturity, and if it's able to do so, it will likely need to accept substantially higher interest rates. In 2030, $3.275 billion of bonds yielding 10.25% mature.
There doesn't appear to be a path out of this debt mess that doesn't involve a restructuring of some kind. Carvana has tried and failed to convince creditors to accept a debt swap , and a group of creditors has proposed a debt-for-equity swap. While the latter would reduce Carvana's debt load, it would also greatly dilute shareholders. So far, nothing has been agreed upon.
Stay away from Carvana stock
Carvana is valued at nearly $6 billion following this year's rally. It's possible that Carvana will be able to use this rally to sell additional shares and use the proceeds to knock down its debt. That would be a smart move, but it probably wouldn't be enough to dramatically change the company's trajectory. Raising $1 billion, for example, would make the next couple of debt maturities more manageable, but the fundamental problem of having a business model that just doesn't work would remain.
Carvana is nowhere close to being profitable – net income was a loss of $286 million on $2.6 billion of revenue in the first quarter of 2023. Because selling used cars is such a low-margin affair, Carvana would need to greatly increase sales to turn a profit, all else being equal.
Carvana spent 18% of revenue on selling, general, and administrative expenses in the first quarter, while gross margin was just 13%. Gross margin can only increase so much, given how competitive the used car market is. Operating costs can come down relative to revenue, but that would require a vast increase in efficiency and/or sales. Even if Carvana was able to close this gap, interest payments eat up another 6% of revenue at current revenue levels.
The bottom line: It's not clear whether it's possible to make these numbers work before debt maturities start causing problems. And even if Carvana successfully walks this tightrope, much larger rival CarMax is valued at about $13 billion. The potential upside is just not that big for Carvana stock.
The incredible rally in Carvana stock this year has surely been exciting for investors, but the long-term picture looks just as bleak as it did at the start of 2023.
