Well, Carvana (CVNA 8.79%) has had an interesting last few years.
After announcing a trifecta of improving earnings numbers, a debt restructuring, and an at-the-market (ATM) stock offering last week, shares of the online used car marketplace are now up about 780% year to date and were, at one point, up over 1,000%. The company has put in a giant recovery from its 2021 and 2022 woes, making it one of the best-performing stocks in the world in recent months. However, shares are still 88% off the high set during the stock market bubble of early 2021, likely due to continued fears over a lack of profitability and growth.
Did Carvana perform a financial engineering miracle and stave off a bankruptcy filing? Here's what investors need to know about the company's recent developments.
Reorganizing its debt load (plus a stock offering)
Carvana's biggest issue over the last few years has been its debt load. After taking on more and more loans to rapidly build and acquire infrastructure for its used car marketplace, Carvana was caught off guard after the industry hit a wall when the Federal Reserve raised interest rates in 2022. This made it more difficult for consumers to finance vehicle purchases.
These loans are long-dated with the first note due in Oct. 2025, so paying the principal on them was not a looming issue. However, with around $6.5 billion in long-term debt -- all with interest rates at around 5% or higher -- Carvana was struggling to sustainably pay the interest expense on its borrowings every quarter. For example, through the first half of 2023, Carvana reported interest expenses of $314 million, which ate up 37% of its gross profit generated in that period.
Last week, the company announced it had made a deal with its bondholders to exchange some of its current debt for new loans under a different structure. The deal looks complicated, but the key points are an exchange of 83% of the company's 2025 and 2027 bonds that will reduce its interest expense by $430 million for each of the next two years.
Why are its bondholders agreeing to this? Because the new loans are backed by Carvana's assets, such as the ADESA auction locations it bought last year. If Carvana ever fails to repay this debt, its lenders will end up owning all this infrastructure.
A positive spin on this deal would say that Carvana just bought itself multiple years of breathing room that will allow it to start investing for growth again. A negative spin would say Carvana just admitted it was unable to pay its debt under this prior structure, making the business technically insolvent. Just because a company's business situation improves does not mean it is now in a good spot.
Investors should also be aware that Carvana announced a $1 billion at-the-market offering, wherein it can sell a maximum of 35 million new shares of its stock to the public. The company has just under 200 million Class A and B shares outstanding at the moment, making this stock sale highly dilutive if all 35 million shares are sold.
Cash-flow concerns remain
Through the first half of 2023, Carvana's revenue declined 25% year over year due to a pullback in automotive transactions and a reduction in marketing expenses. At the same time, the company is getting closer to profitability with its net loss shrinking from $945 million in the first half of 2022 to $391 million this year. Subtract the interest expense Carvana will save going forward, and the company will likely be profitable over the next few years, especially if the used car market picks up steam.
The big question with Carvana now is whether it can reach profitability and invest for growth at the same time. Even with the decline in recent quarters, revenue at Carvana has grown 620% over the last five years to $11.8 billion. However, over that period, the company has never generated positive free cash flow over a 12-month period with its cash burn consistently worsening until it aggressively reined in spending last year.
Data by YCharts.
Is the stock cheap?
Running through the numbers, it looks like this new debt deal has saved Carvana, at least for the next few years. Unless something drastically changes with its unit economics, the next few quarters should mean positive cash-flow generation. Don't forget the up to $1 billion coming in from the ATM offering, too.
But that has no bearing on whether you should buy shares today. After the recent run-up, Carvana trades at a market cap of $7.4 billion. Over the long term, management is guiding for its earnings before interest, taxes, depreciation, and amortization (EBITDA) margin to reach at least 8%. This could optimistically mean a net income margin of around 5%, which would equate to $600 million in net income based on its trailing revenue number.
Long story short, Carvana should be able to generate enough cash to repay the billions of dollars in debt remaining on its balance sheet. However, unless the company can significantly grow its revenue while also expanding its profitability, it will likely struggle to generate cash it can return to shareholders.
Given the amount of uncertainty that still surrounds the company's prospects, investors should think twice before buying into Carvana's recovery at current levels.
