After tanking 98% in 2022, Carvana (CVNA 8.79%) shares are bouncing back nicely this year. They have soared a whopping 752% in 2023 (as of Aug. 21), a clear sign of renewed optimism from investors.
The used car e-commerce company is winning over shareholders by posting better-than-expected financial results. But that doesn't mean it's time to automatically rush into buying the stock now.
Let's look at one obvious reason that Carvana's stock is a screaming buy and one reason investors should stay away.
Growth potential
Carvana has grown so rapidly over the past several years (revenue of $3 billion in the latest quarter versus revenue of $42 million in all of 2014) because it offers a superior alternative for customers looking to buy used cars. It's that simple: There's a clear product-market fit that the business has benefited from.
The typical car-buying process -- where a customer walks into a local dealership, picks from a limited inventory, haggles with a salesperson, and then has to secure financing -- can take hours out of the day and be very stressful. By developing an e-commerce model, Carvana allows the entire process to be completed online in just a few minutes. What's more, the car is delivered for free, and there's a seven-day return policy. The company has taken the best parts of the e-commerce experience and applied them to the used car industry.
In 2022, Carvana sold 412,296 retail units. While that figure is up more than nine-fold compared to 2017's total, it's a minuscule amount in the grand scheme of the industry. There were 40.6 million used car transactions in 2021 in the U.S. with an estimated value of $1.2 trillion. It's anyone's guess how much of the total market Carvana can command over time, but the addressable market is truly massive.
Management's long-term financial goal is to generate an EBITDA (earnings before interest, taxes, depreciation, and amortization) margin of between 8% and 13.5%. If the leadership team's target is one day reached, it's likely the company's market cap will be multiples of the current $7.6 billion.
Uncertain outcome
Investors can't forget that Carvana remains a risky business. This is still the case despite management finding ways to provide temporary relief by restructuring $1.2 billion of debt and lowering interest payments by $430 million in each of the next couple of years.
There is competition in the industry not only from traditional dealerships but from formidable opponents like CarMax, Vroom, and AutoNation. All want a piece of the pie, so Carvana has to stay on top of its game to gain market share. This will undoubtedly make it harder to improve the company's finances.
What has also become strikingly clear since the start of 2022 is just how dependent Carvana is on favorable market conditions not only for its success but simply for its survival. What happens with interest rates, used car prices, inflation, and supply chains is outside the company's control, yet it has a huge effect on its results in any given period. This means investors are exposed to the whims of unpredictable macro forces.
Carvana's potential can't be denied. The issue, though, is that there's still a ton of uncertainty surrounding the company's future. In other words, there is still a meaningful probability that the business will be forced to file for bankruptcy at some point in the next few years. Consequently, it's difficult for investors to have a high level of confidence in owning shares with the financial position still something to worry about.
Weigh the pros and cons
I can understand why someone would want to allocate a small part of their overall portfolio, say 1%, to buying Carvana shares. The upside is huge should the company execute on its strategy and resume strong growth trends in the years ahead. In this scenario, the stock can be much higher than it is today.
On the other hand, it can't be denied that this is a risky bet. Carvana's management team deserves some credit for weathering the last year and a half, including a shaky economic environment. But what if a severe recession ends up happening? How will the company perform in the situation? It still has a huge debt burden, something that could cause pain in a downturn.
Investors have a lot to think about before making an informed decision about the stock.
