Carvana (CVNA 8.79%) shares are on fire right now, with the stock skyrocketing on debt refinancing news. But investors should step back from the hype and take a close look at the business. Yes, the used-car dealer is moving in the right direction, but it's still not a reliably profitable company. That's a problem.
For Carvana, good news is bad news
The big story for Carvana happened on July 19, when the company announced it had reached an agreement with key lenders to give it some financial breathing room. The stock rose dramatically because, without such a deal, there was a concern that its heavy debt load could push it into bankruptcy court.
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There's no question that this is good news. The deal will help reduce debt and lower interest costs, and it pushes out maturities, giving management more time to help the company reach profitability. But here's the rub: It should be a big problem for investors that a deal like this was needed in the first place. Companies that are performing well don't have to fight with their lenders for concessions the way Carvana did. In fact, strong companies don't have to ask for concessions at all.
In fairness, Carvana is a fairly young company that has been building out its operations. That's an expensive proposition and justifies, to some extent, the company's ongoing red ink. But what the debt overhang highlighted is that Carvana tried to grow much too quickly. And that overzealous pursuit of growth nearly caused the company to implode.
Some troubling numbers for Carvana
For example, over the past 12 months, management reduced costs by $1.1 billion. That's a rate that should make you question why it was spending over $1.1 billion more than it needed to before business headwinds resulted in an overhaul. On the flip side, pulling back so hard, so fast, is likely to have an impact on the business and its growth prospects.
In the second quarter, for example, the company sold 35% fewer cars than it did a year ago. It generated 24% less revenue. A leaner company isn't necessarily a bad thing, but Carvana is definitely operating from a position of weakness today, highlighted by its need to ask for help from its bondholders -- not to mention that the company lost $0.55 per share on a GAAP basis, an improvement over the previous year but still a loss.
The company, meanwhile, is highlighting an increasing "gross profit per unit," or GPU, which is supposed to show how much Carvana makes on each car it sells. But this figure is just gross profit divided by the number of cars the company sells. It ignores the other costs required to run a business, like those interest costs it has to pay, along with selling, general, and administrative expenses. Those costs exceeded $600 million in the second quarter of 2023, versus a gross profit of $499 million.
Simply put, Carvana is trying its best to highlight the positives and some investors are, at least for the moment, buying into that story. But there's still a lot of work to be done before this used-car dealer is sustainably profitable. That helps explain why, despite a massive stock advance following its debt rejiggering, share prices are still down more than 85% from their high-water mark in mid-2021. And don't forget, while its lenders granted the company some extra breathing room on the debt front, which will probably help improve financial performance over the near term, it still has to do something about its heavily leveraged balance sheet at some point. Kicking the can down the road doesn't eliminate the can.
Tread with caution on Carvana stock
Conservative investors should probably avoid Carvana. At this point, the stock looks like a turnaround play at best. And buying into turnarounds is something only the most aggressive investors should be attempting. Moreover, after a huge stock surge, a lot of good news has been priced into the stock in a short period of time. That's not to suggest that Carvana can't become a sustainably profitable company, but it just isn't there yet and it still has major issues to resolve before it does.
