Picking winners is important in investing, but avoiding losers is equally so. Connected-fitness company Peloton (PTON 4.29%), PC and printing giant HP Inc. (HPQ -0.46%), and online-car marketplace Carvana (CVNA 8.79%) are three stocks that I'll be staying far away from in 2024 and beyond. Here's why.
Peloton
Connected-fitness company Peloton has made some positive changes since its turnaround efforts began under CEO Barry McCarthy. Most importantly, it has shifted its focus from its pricey fitness equipment to its app. There are now multiple subscription tiers that don't require Peloton hardware, significantly broadening the brand's appeal beyond those willing to buy expensive home-exercise equipment.
Unfortunately, Peloton's turnaround isn't showing much progress. Hardware sales are still sinking, down 12% year over year in the most recent quarter. More concerning is that subscription revenue rose by just 1%. The total number of members dropped 4% year over year, the number of paid-app subscriptions tumbled 13%, and the paid-app monthly churn was 6.3%. Peloton is losing subscribers faster than it's gaining new ones.
While Peloton has greatly reduced its losses by slashing costs, the company is still burning cash. Free cash flow was a loss of $83.2 million in the most recent quarter. Peloton has around $750 million of cash on hand, so it can continue to burn cash at this rate for a couple of years before push comes to shove. But if the company can't turn things around soon, a difficult and expensive capital raise will eventually become necessary.
Peloton's fitness equipment is basically a break-even business, so selling more hardware won't help the bottom line. Boosting the subscriber count will, but the company is clearly having trouble doing that. Gross profit from subscriptions did rise by 3% in the most recent quarter, driven by a higher mix of pricier subscription tiers. But that progress is far too slow given the company's limited time to turn things around before liquidity becomes a real problem.
HP Inc.
HP operates in two core businesses that are unattractive in different ways. The company manufactures PCs, and it sells printers and printing supplies.
The PC business was more lucrative than usual during the pandemic as demand soared, but that demand has quickly fallen back below pre-pandemic levels. HP has kept its PC operating margins up, but there's little reason to believe the PC business will be structurally more profitable once the dust has settled compared to before the pandemic. PCs are at best a slow-growth business.
The printing business is far more profitable, with operating margins in the high teens thanks to the sale of high-margin supplies. But HP's printing sales have been stuck in a long decline. The best-case scenario is very slow growth. One estimate puts the global commercial-printing market expanding by 2.8% annually through 2030, and that may be overly optimistic.
HP is essentially wringing out as much profit as it can from two nearly stagnant businesses. The company is still generating plenty of cash, calling for free cash flow between $3.1 billion and $3.6 billion in fiscal 2024. That's up from fiscal 2023 but well below fiscal 2022. But it's not clear to me how HP will grow free cash flow over time. HP stock trades for less than 10 times free-cash-flow guidance, but if free cash flow isn't sustainable, all bets are off.
Carvana
Online used-car marketplace Carvana has, for lack of a better phrase, made a deal with the devil. Buried by excessive debt, the company struck a complex deal with creditors earlier this year. There was an immediate reduction in the face value of Carvana's debt after the deal as the company traded existing debt for new debt. And for two years, cash-interest payments will be slashed. That's certainly good news for the company's cash flow.
However, the new debt that Carvana has taken on carries far higher interest rates, and Carvana will be paying interest in the form of additional notes rather than cash for the first two years. After two years, Carvana will be paying 9% cash interest on all this new debt. Cash-interest payments will shoot back up, and the company will possibly be in a more precarious position than it was before the deal. This new debt is also secured by Carvana's assets, while its old debt was not. Long story short, this isn't the kind of deal a company makes unless it has absolutely no choice.
Sales are still crashing for Carvana, although it has boosted its gross-profit per vehicle substantially. Net income jumped into positive territory in the third quarter but only because of a large, one-time gain from debt extinguishment. Drawing down vehicle inventories has boosted cash flow, but that's not something the company can do indefinitely.
Following a rally this year that makes no sense to me at all, Carvana is valued at nearly $11 billion. That's nearly as much as CarMax, which long ago figured out how to buy and sell used vehicles profitably. The best-case scenario for Carvana, given that its debt problem hasn't gone away even if cash-interest payments are temporarily lowered, appears to be eking out a small profit. That's not nearly good enough to justify the valuation.
