Don't look now, but Carvana (CVNA 8.79%) is the top-performing stock on the market so far in 2023, as of Aug. 21. That excludes companies worth less than $300 million or that trade over-the-counter. But with these two caveats, Carvana stock is ahead of everyone else with an astounding 715% year-to-date gain.
For those keeping score, this means that if you had invested $1,000 in Carvana stock at the start of the year, you'd have over $8,000 now.
There's a flip side to this stunning statistic. If you had invested $1,000 in Carvana stock one year ago, you'd only have about $900 now. In short, this stock has been incredibly volatile over the last 52 weeks, dropping more than 90% in 2022 before jumping to its big gains in 2023.
Carvana stock has been volatile for good reason. And as we'll see, the ride might not be over yet.
Imminent bankruptcy off the table
When Carvana stock dropped more than 90% to end 2022, the market was essentially predicting that the company would go bankrupt. The stock plummeted to a price-to-sales (P/S) valuation of less than 0.03, whereas it had historically traded at a P/S ratio of at least 1. The market was overwhelmingly pessimistic about its long-term viability as a business.
CVNA PS Ratio data by YCharts
When Carvana stock traded at P/S ratio of less than 0.03, it was undeniably cheap. But investors were nonetheless hesitant to buy shares. After all, it doesn't matter how cheap a stock is; if it goes bankrupt, then shares will still drop further.
Carvana risked bankruptcy because it operated at a loss, funded its business with low-interest debt that was no longer available, and stuffed its sales channels with used car inventory right as consumer demand slowed. All of a sudden, the high-growth business experienced a drop in sales, losses grew, and the bill for its debt load of over $8 billion was coming due.
Fortunately for shareholders, Carvana's management renegotiated some of its debt. This pushed some of its liabilities out, buying it time. For this reason, the market is no longer pricing the company for imminent bankruptcy. That's why the stock is such a huge year-to-date winner.
Huge challenges ahead for Carvana
But all this positive news is now in the rearview mirror. As mentioned, Carvana has experienced a swift slowdown in demand. In the second quarter of 2023, the company sold 76,350 retail units (vehicles), which was down 35% from a year ago.
The third quarter is expected to be almost as bad. The outlook from Carvana's management says it should sell about the same amount of units in Q3 as it sold in Q2. If that's what happens, it will mark a 34% drop from the prior-year quarter.
Carvana does expect to make a profit of $75 million for Q3 in adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA). However, the guidance assumes no substantial changes in the used car space. And the space is indeed changing rapidly.
For example, the Manheim Used Vehicle Value index shows an 11% drop in used-car values from March to August, which is a quick decline as far as this normally goes. The risk is that Carvana won't be able to sell vehicles for the prices it expected, leading to lower profitability per vehicle in upcoming quarters.
There's another challenge for Carvana to overcome. According to a recent report from The Wall Street Journal, delinquencies on car loans just reached the highest level since 2006. Therefore, it's possible that consumers are already stretched too thin and that used car prices will need to come down even more to stimulate demand.
Can Carvana create shareholder value now?
For the sake of argument, let's optimistically assume that Carvana overcomes the current industry challenges and hits its profitability targets this year. Even still, I believe it will be hard for the company to create shareholder value for the foreseeable future. Here's why.
First, Carvana has improved its cash flow in 2023 partially because it has lowered inventory by 31% since the start of the year. Think of it as cashing out an old investment. But management says it wants to soon return to growth. That will require more inventory, which means it will need to fund that inventory. In other words, cash flow could get complicated again for Carvana.
Second, one of the sources for Carvana's funding will potentially come by diluting current shareholders. It has a plan in place to raise up to $1 billion by selling stock, which will make current shares less valuable.
Third, Carvana's EBITDA goals exclude interest on its debt, and it still has a substantial debt load. Much of the money it earns before interest will wind up going toward its debt, leaving little for the business or shareholders.
In conclusion, it appears that Carvana has set itself up to continue doing business and potentially even return to growth. However, it doesn't look like shareholders will get to see any of the value for some time yet, which is why this isn't a stock I'd buy today.
