Carvana (CVNA 5.25%) has emerged as one of the market's biggest turnaround stories, with shares up more than 800% over the past year and more than 35% since the start of the year. Those kinds of gains garner a lot of attention, and investors are particularly interested in insight on whether the rally will continue.

Is the stock a buy now, or will Carvana's path hit a dead end?

An improved financial position

The online used car retailer has staged a remarkable comeback considering it wasn't too long ago that the threat of bankruptcy and widening losses sent shares to less than $4 back in 2022. The good news is that Carvana has taken important steps to improve its situation. The stock closed April 22 at $71.44.

A major debt restructuring deal announced last year is saving the company $430 million in annual interest expense, improving its liquidity situation. Carvana has also benefited from the resilient U.S. economy providing a tailwind for consumer spending.

Indeed, 2023 turned out to be a record year for profitability, driven by sharply higher margins and a new focus on sustainable growth.

Even as the total number of cars Carvana sold last year was down from its early-pandemic-era high, the company managed to increase gross profit per unit. Carvana reported an adjusted gross profit of $5,984 per vehicle sold in 2023, nearly double the $3,022 in 2022. That trend reflects several cost-saving initiatives to improve logistics and operating efficiency.

Management expects stronger sales volumes through 2024, along with higher adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) compared to 2023. That guidance has likely boosted the stock, with investors signaling confidence in the company's strategy.

Possible bumps in the road

The main near-term challenge for Carvana is the macro backdrop, which appears to have become more complicated.

A consequence of the stronger-than-expected economic conditions that have defined much of the past year has been stubborn inflation readings pushing interest rates back toward cycle highs. Similarly, an uncertain timetable for potential Fed rate cuts has contributed to recent stock market volatility.

This is a problem when it comes to Carvana and the used car market. According to a report by Edmunds, the average used car loan rate reached 12% in Q1, a 15-year high. Car buyers looking for financing relief will need to keep waiting.

While that demand-side dynamic is partially balanced by data from the same Edmunds report suggesting used car prices are down about 4% over the past year, this trend creates a headwind for Carvana's margins.

A lull in used car market activity at a time when average selling prices are down makes the company's goal of increasing unit-level profitability that much more difficult.

The risk now is that previously issued 2024 targets and analysts' estimates may be too optimistic, requiring a downward revision of expectations, and leading to a slumping stock price.

What's next for Carvana?

The stock's spectacular rally over the past year is unlikely to be repeated anytime soon. Given the uncertainties, I believe a wait-and-see approach makes sense before taking a bullish position on the stock at the current level.

Carvana is set to report first-quarter earnings on May 1. It'll be a good opportunity for management to update shareholders on real-time conditions. Ideally, investors want to see signs that sales activity remains solid and margins are trending higher.

Carvana's biggest weakness may be its nearly $7 billion pile of debt, which will likely require more consistent free cash flow to get it down to a more sustainable level. Ultimately, Carvana is a high-risk stock, and I expect shares to remain volatile.