Is It Finally Time for Investors to Jump On the Carvana Bandwagon?

Carvana (CVNA 8.79%), the well-known online used-car dealer that was the darling of Wall Street during the COVID-19 pandemic's height, fell on incredibly rough times in the following years. Interest rates climbed, sales slowed, inventory piled up, and it burned through billions in cash.

Investors had to watch as Carvana sputtered from an all-time high of $370 per share to below $4. Now that Carvana has restructured some critical debt and turned in an improved second quarter, is it time to jump back on the bandwagon after the stock has soared over 800% year to date?

The good news

Let's start with the good news from Carvana, because it did make some improvements during the second quarter.

During the quarter, Carvana reported records for total gross profit per unit (GPU), adjusted EBITDA margin, and further trimmed selling, general, and administrative (SG&A) expenses. Management had reversed course from its previous strategy of rapid growth at all costs, to slower and more profitable sales to curb cash burn and shore up its financials.

There's evidence that so far it's taking hold. Retail units decreased 35% during Q2, but revenue dropped a more modest 24%, suggesting a focus on a more lucrative vehicle sales mix. Total gross profit jumped 26% to $499 million, and total GPU jumped from $3,152, during the prior year's second quarter, up to $6,520.

Net loss margin checked in at -3.5% compared to -11% a year ago, while adjusted EBITDA margin improved to 5.2%, sequentially, from the first quarter's mark of (0.9%).

Perhaps the biggest boon to Carvana's near-term potential was management coming to an agreement with a substantial group of noteholders representing over 90% of the company's outstanding existing senior unsecured notes.

Carvana is essentially pushing out some of its debt payments by two years. The trade-off is that the group of noteholders receives a higher interest rate in the future. Their once unsecured notes are now secured with company assets as collateral, and are higher up in the ranks to be paid out if the company were to go bankrupt and liquidate assets to pay back some creditors.

The debt restructuring will reduce Carvana's interest expense -- which was already high and expected to reach around $600 million annually -- by over $430 million per year for the next two years. The move, while not an end-all solution, certainly provides financial flexibility in the near term.

And the bad news?

The bad news is that while this does indeed give Carvana a lot of relief in interest expense on its debt for two years, it's really just kicking the can down the road. In two years, the interest rate will be more expensive. Investors are left hoping that Carvana can drive substantial profitability, while reducing cash burn, before that debt begins to mature. More specifically, Carvana's debt was carrying interest rates that ranged between 5% and 10% -- with the largest chunk being at the higher 10% rate -- and now, in two years, that debt will be at a 13% interest rate during the first year of payments.

The other bad news is that while Carvana has made improvements on its net loss margin, adjusted EBITDA, and GPU, some of that improvement is from non-recurring items as it sold off inventory, among other moves.

In fact, its record total GPU of $6,520 was aided by roughly $900 of non-recurring benefits, and its adjusted EBITDA of $155 million was aided by roughly $70 million of non-recurring benefits. Make no mistake, improvements were made, but whether or not management can sustain these levels of improvement without those temporary benefits remains to be seen.

Is it time to jump on the bandwagon?

It's tempting for investors to see Carvana's year-to-date gains and think that the worst is in the rearview mirror, but it remains a risky investment. You would essentially be gambling that management can substantially drive profitability in its business, which it has yet to do in its limited history, within two years. And the word "gambling" should never be used in the same sentence as "investing."

Carvana has made improvements, but it has much, much further to go before individual investors should feel comfortable jumping on the bandwagon. The two-year countdown has started. Stay tuned -- it will be an interesting ride.