Man, what a difference a few months can make. Things were looking dire for Carvana (CVNA 8.79%) at the start of 2023. Shares of its stock were off 99% from all-time highs after a few rough earning reports, and its bonds were indicating Wall Street was worried about a potential bankruptcy filing. The used-car marketplace was hemorrhaging cash after it grew expenses too quickly and had to react to slowing consumer spending on automotive purchases.
But as we sit here today, shares of Carvana stock are up over 700% year to date, making it one of the best-performing stocks in the world in 2023. Why have shares exploded higher? Is Carvana now in a bubble ready to pop? Let's get to the bottom of this highly volatile stock and see what the answers are.
Up 700% this year, but why?
There seem to be a few reasons why Carvana is up so far this year, some related to the macroeconomic environment in the United States and others more specific to the stock.
It looks like inflation in the U.S. is starting to cool, with consumer prices growing at a decelerating rate for several months in a row now. This could mean the Federal Reserve is close to pausing its interest rate hiking cycle. Rising interest rates negatively affect a used-car marketplace such as Carvana by making it harder to finance vehicle purchases. This dynamic has caused quarterly vehicle sales sold through Carvana to decline in recent quarters.
If inflation cools back down to the Fed's 2% target, this headwind may start to abate, helping Carvana get back to growing vehicle sales again.
We also saw used-car prices rise in recent months. According to the CarGurus Index, used car prices are up 1.5% over the last 90 days. Carvana earns more revenue when selling cars if used-car prices are generally higher but also can earn a larger spread when it buys and sells a vehicle from consumers.
But most importantly may just be the fact that Carvana is a heavily shorted stock. Estimates have the stock's short interest at more than 50%, which means more than half of its shares outstanding are being loaned to short sellers. When a heavily shorted stock starts rising quickly, short sellers may rush back to buy back their shares in order to avoid huge losses. This buying pressure can further drive up the price of a stock in the short run in what is known as a short squeeze, which is likely happening to Carvana.
Fundamentals paint a bleaker picture
While short squeezes can drive prices in the interim, investors focused on the long term should ignore them. If you are to buy shares of Carvana at these prices, you need to think the company can generate more in cash than it spends. Even though investors seem much more optimistic about Carvana, its financials still look -- to put it lightly -- dire.
Last quarter, which covered the first three months of 2023, Carvana generated just $341 million in gross profit, paid $159 million in interest expense on its debt, and posted a net loss of $286 million. Over the last 12 months, it has burned $1.1 billion in free cash flow. At the end of the first quarter, it had just $488 million in cash on its balance sheet and $6.55 billion in long-term debt. So, yeah, not an ideal balance sheet.
To be fair, Carvana's cash burn has greatly improved from last year when at one point it was on pace to burn $3 billion in free cash flow. However, even if the company can get this business from burning a billion dollars in cash a year to generating profits for shareholders, a lot of these profits will go to paying interest and principal payments on its huge debt load. This will leave little -- if any -- cash available for Carvana management to return to shareholders.
From my seat, that doesn't make the share price worth very much.
CVNA Free Cash Flow data by YCharts.
Don't get caught up in the hype
Rapidly rising stock prices may excite you. They may even hypnotize you into thinking making money in the stock market is easy. All it takes is to buy stocks that are going up, right? Investors from 2022 (which was only last year!) know it's not that simple.
Don't let this happen with Carvana. The business consistently fails to generate cash, has terrible unit economics, and is saddled with a ballooning debt load. Investors will do well to avoid buying Carvana after its recent 700% price surge.
