One of the best-performing stocks in 2023 has been struggling used car marketplace Carvana (CVNA 8.79%). Its shares are up nearly 800% as of this writing, crushing the gains of the broad market indices.
After a tumultuous year for Carvana in 2022, investors have quickly bid the stock up, but it still remains 88% off its peak price.
Even though this speculative company is benefiting from strong investor momentum, it's still my top growth stock to avoid in 2023. Here are three reasons why.
Kicking the can down the road
One of the catalysts that has propelled Carvana shares this year was the news that the management team negotiated new terms with its debt holders. The company was able to reduce its debt by $1.3 billion by essentially swapping out unsecured notes with new notes secured by the company's assets. Moreover, Carvana will save $455 million on interest expenses in each of the next two years. CFO Mark Jenkins called this a "win-win transaction."
The issue, though, is that this basically just buys Carvana more time to reach better financial footing. What if in a couple of years, the company is still struggling with its debt burden and lack of profits (more on this below)? Then, company assets could be given up.
Carvana has also issued fresh equity in the amount of $351 million in the past couple of months in two separate transactions. This provided much-needed liquidity for the company, but it dilutes existing shareholders.
While the business might have dodged the bankruptcy it was heading for late last year, there's still a lot of uncertainty around the Carvana's long-term financial viability. That's a risky place to put your hard-earned capital.
Where are the profits?
Carvana's entire business model will only succeed if it reaches a certain level of scale. That's because there is so much capital investment required to build out the nationwide logistics infrastructure. Right now, the company is far from being profitable. The net loss in the second quarter, while an improvement over the year-ago period, totaled $105 million.
In the latest shareholder letter, management presented long-term financial targets for the company. The most important is to achieve a positive EBITDA (earnings before interest, taxes, depreciation, and amortization) margin between 8% and 13.5%. But there was no timeline provided for this outlook, and in the first six months of 2023, Carvana's EBITDA margin was below 2%.
To their credit, executives are focused on cost control efforts with $1.1 billion in annualized cost reductions over the past 12 months. Time will tell if this helps put Carvana on the path to sustainable profitability.
The era of zero interest rates is over for now. Businesses that benefited from easy access to capital to fund growth over the past decade must now show some financial discipline.
A cyclical enterprise
Reaching a deal with debt holders to restructure terms and finding ways to cut expenses are fully in Carvana's control. Investors want to see management take these necessary steps, which could help ensure the company's survival.
However, it's obvious that Carvana's success is also largely dependent on robust external factors. Used car prices can be affected by things like supply chain issues and the recent United Auto Workers strike. What the Fed does with interest rates has a direct impact on the affordability of cars too.
This makes the business a truly cyclical enterprise. The company can take all the drastic measures it wants, but if interest rates and consumer confidence, as well as other macroeconomic indicators, aren't where they need to be, demand for Carvana's used vehicles will be under pressure.
Each of these points represent compelling reasons to be wary of Carvana, but taken together, investors are probably better off passing on this volatile stock.
