Carvana (CVNA 8.79%) shareholders had a distressing 2022. Shares of the used car marketplace fell 98% from highs, meaning that if you had invested $100 in its stock at the highs, it was trading at a value of just $2 at the end of last year. Investors were concerned over mounting losses, a high debt load, and stagnating demand for used car purchases in the United States. Many investors thought the company might file for bankruptcy.
But in 2023, everything changed. The stock has rocketed 745% higher this year, even accounting for a 20% pullback in late September. The company has turned around its losses and extended debt maturities, which has investors optimistic about the company yet again. Does that make now the time to hop on the Carvana train? Or is this just a dead cat bounce? Let's investigate further.
Cutting spending -- a path to profitability
The big problem Carvana faced in 2022 was that it overextended itself right into a cyclical downturn of the used car market. The company makes money when people buy and sell used automotives through its website and mobile application, along with add-ons such as vehicle financing.
So when the company aggressively expanded to start last year and made a $2.2 billion acquisition of the ADESA physical car-auction business right when used car sales started to plummet, its financials got wrecked. (Capital expenditures at one point hit close to $1 billion over a trailing-12-month period.)
In 2022, Carvana saw its gross profit decrease by 35%; net-loss margin hit over 20%; and free cash flow reached negative $1.8 billion. With less than $500 million in cash and $6.6 billion in debt on the company's balance sheet by year-end, many investors were worried that Carvana was going to run out of money soon. Management was preaching that it was cutting costs to help improve its cash burn. Investors clearly didn't believe them.
But it looks like the company has been able to thread the needle, extending its debt maturities while also carving a path to profitability. Net-loss margin shrank to negative 3.5% in the second quarter, a major improvement over 2022. In August, Carvana completed a debt exchange that will lower its interest expense by $455 million for each of the next two years.
Investors have applauded both moves and see a path for Carvana to start generating a profit soon. In Q2 of 2023, Carvana paid $155 million in interest expense on its debt, or around 31% of its gross profit in the period. As this interest expense decreases, the company should have a much easier time generating positive net earnings.
What does the future hold?
So it looks like Carvana is on its way to flipping back to profitability. There is one problem, though. It is doing so by cutting back on costs rather than growing and reaching economies of scale. It has drastically pulled back on operating expenses like marketing and research. Last quarter, operating expenses were $452 million, which was 37% off of their all-time high.
While this is definitely a viable way to get to profitability, investors should be wonder about how Carvana is going to market itself and grow in future years. Last quarter, revenue slid to $2.97 billion compared to $3.88 billion a year ago, a lot of which was due to its pullback on operating expenses.
Maybe the company will start growing again if used car affordability starts to recover, but it is possible the company was forced to abandon its long-term plans due to the cash crunch it faced at the end of last year. It may have saved the company from bankruptcy but limited how big it can get over the next few years.
Is too late to buy the stock?
CVNA Net Income (TTM) data by YCharts.
Today, Carvana trades at a market capitalization of $8 billion after shooting higher this year. Add on $7.4 billion in net debt and the stock has an enterprise value of $15.4 billion.
If these cost cuts eventually lead to net-income margins of 10%, Carvana would generate $1.18 billion in net income on its trailing revenue of $11.8 billion, which I should note has been declining in recent quarters. That would give the stock an enterprise value-to-earnings (EV/E) multiple of 13. Not bad and much cheaper than the market average. Investors will probably achieve decent returns if Carvana can hit these numbers within the next few years.
However, these are a lot of "ifs" and theoretical profits. Carvana has never generated positive net income over a trailing-12-month period, and any investor should question why that is. With a huge debt pile, declining revenue, and a stock price that has gotten expensive again, it is best to park your money elsewhere for the time being.
