There is an ugly situation developing.
In the past, Carvana was a Wall Street darling for its rapid growth and eye-catching car vending machines. In August 2021, the stock hit an all-time high of $370, over 2,300% higher than its IPO price. Its value has dropped 98% since its peak, to $7.70 per share. This article will explore three reasons why the downside is likely to continue.
Do They Need Some New Pieces?
During the COVID-19 pandemic, Carvana performed well, along with many stay-at-home companies. Revenue for the company increased by 65% and 129% in 2020 and 2021, respectively, on its online car dealership platform. Unfortunately, the party has come to an end.
In the third quarter, Carvana’s revenue dropped 3% from the previous year to $3.4 billion, while cars sold dropped 8% (to 102,570). It is not necessarily a big deal for a mature company to experience a slight decline in quarterly sales. The slowdown, however, could spell disaster for a “growth” company like Carvana because its business model hasn’t reached the scale it needs for consistent profitability. During the period, the company’s net loss surged from $68 million to $508 million, an increase of almost 650%.
This situation cannot be resolved easily since the company only has $316 million in cash and $6.6 billion in long-term debt.
Management could kick the can down the road by raising more debt to refinance its existing loans. In addition to increasing bankruptcy risk, this move could further crush profit margins due to rising interest expense (which already amounts to $153 million per quarter).
As another option, the company might sell more of its stock to dilute its equity. This reduces the number of votes shareholders have in the company and their claim to future earnings and cash flow.
As the macroeconomic environment continues to worsen, including increases in inflation and interest rates, Carvana’s biggest issue is a worsening macroeconomic environment. According to the operation, the price of used cars has plummeted 15% from its peak in January. Inflation reduces the purchasing power of consumers, while higher interest rates increase the cost of financing a car.
In addition to increasing Carvana’s interest expense on its current debt, the rising rate environment also makes taking on new loans more expensive.
So, What Should We Do?
We shouldn’t expect these headwinds to last forever, though. Eventually, the Fed will be able to lower interest rates as needed if everything proceeds according to plan. However, it remains unclear whether Carvana can last that long.
According to Morgan Stanley analysts, it has a price target of $0.10 per share in the worst-case scenario, and 40% of its outstanding shares are shorted, highlighting market pessimism.
Compared to the S&P 500 average of 2.4, Carvana stock has a price-to-sales ratio of just 0.05. As a result, investors who believe the company can stay out of bankruptcy for a while would make a reasonable return by investing in Carvana.
Despite this, investing in Carvana is risky. There is a real possibility that the stock could crash to zero as debt and losses spiral out of control.