Should You Buy Carvana (CVNA) on the Possibility of a Rebound?
Carvana CVNA, a pandemic darling stock, suffered a brutal 2022 to the extent that the survival of the company was put to question. The used car e-retailer— encumbered with debt— lost 98% of its value last year. The company’s CEO Ernie Garcia is of the view that Carvana has largely bottomed out. He has laid out plans and targets to get the company back on track. Can the company live up to the expectations it has set for itself? We can only hope so.
After a massive sell-off last year, shares of CVNA have jumped around 80% so far this year. Yesterday, the stock popped up more than 6% after the company unveiled plans to restructure its $9 billion debt load, which somewhat reduces the chances of a bankruptcy. It also expects a narrower year-over-year core loss in the first quarter of 2023.
It does seem that management is pivoting in the right direction. So, is now the time to buy Carvana, especially when the stock is trading at some 94% off its 52-year high? Well, there are a few things to consider here. But before discussing that, let’s take a look at what went wrong with the company last year.
CVNA’s Drastic Crash in 2022
From being the top auto retail stock of 2020, Carvana completely wiped out its pandemic-fueled gains last year. In 2020, the robust demand for personal mobility amid coronavirus fears, coupled with an early-mover advantage in digital sales, gave the stock a boost. Carvana benefited from rising demand and low prices of used cars. Low interest rates also aided the company. In 2022, most of the tailwinds that helped Carvana achieve triple-digit percentage growth on the bourses in 2020 just faded away.
Supply chain snarls — a byproduct of COVID-19 — which got exacerbated by the Russia-Ukraine war, high interest rates and rising used vehicle prices wrecked the company. Last year witnessed the largest annual interest rate increases in four decades. Additionally, industry-wide used vehicle prices in 2022 rose 8% from 2021 and 55% compared to 2019. A double whammy of rising interest rates and used vehicle prices led to affordability issues. Carvana stated in its last quarterly report that the monthly payment for its customers buying used vehicle in 2022 was 45% higher than 2019. As such, the sales volumes of the company were hit hard last year.
Well, Carvana has been in the business for a good 10 years and went public in 2017. But it has not managed to turn an annual profit yet. Last year, its net loss widened to $2,894 million from $287 million in 2021. To top it all, the company is drowning in debt. The firm’s decision to fund the ADESA U.S. operations acquisition (which closed in May 2022) partially with debt wasn’t quite prudent considering it was already bleeding red ink. Carvana’s $3.3 billion bond sale—to fund the ADESA buyout as well for general corporate purposes— came with a hefty annual interest payment. As of Dec 31, 2022, Carvana’s long-term debt rose to $6,574 million from $3,208 million as of 2021-end. Its debt-to-capital ratio stands at 1.14 compared with the industry’s 0.27.
The company’s brand value was so severely tarnished that it had to take a one-time goodwill impairment charge of $847 million last year.
Due to a cocktail of unfavorable factors, including a hawkish Fed, rising used vehicle prices, elevated leverage, goodwill write-off, declining sales volumes and compressing margins, Carvana hit a wall in 2022.
CVNA’s Shift in Policy: Is it Paying Off?
Amid mounting losses, Carvana has started prioritizing operational efficiency over growth. During the second quarter of 2022, Garcia said, "We have shifted our priorities for the first time in company history to favor efficiency and cash flow in recognition of the changes to the market and the economic landscape, as well as to enable us to quickly adjust to changes in our industry that had caused our expenses to be out of balance with sales volumes."
The company is actively focusing on trimming advertisement costs and payroll expenses. While these initiatives did generate some savings over the course of 2022, it remains to be seen if the company can reach its profitability goals.
Carvana has set for itself some ambitious goals and it needs to prove itself. The company aims to complete an annualized SG&A reduction of over $1 billion by the second quarter of 2023, compared to the first quarter of 2022. Management targets to achieve breakeven adjusted EBITDA, although it has not stated a timeline for the same. Eventually it hopes to generate significant positive adjusted EBITDA and FCF in the years to come.
On the last earnings call, Carvana stated that it expects GPU to have reached the lowest point in fourth-quarter 2022 and would head back to levels above $4000. Encouragingly, per the company’s preliminary first-quarter 2023 results released yesterday, Carvana expects total non-GAAP in the band of $4,100-$4,400, implying an improvement from $2,985 in the year-ago quarter. It also expects a year-over-year decline in SG&A in the first quarter of 2023, driven by continued focus on cost containment efforts and lower advertising spend.
On a more positive note, CVNA expects adjusted negative EBITDA in the band of $50-$100 million, implying improvement from $348 million incurred in the corresponding quarter of 2022, driven by higher GPU and lower SG&A costs.
Going by the preliminary results, it seems that the company’s cost-cut efforts have started to bear fruits but it’s still too early to jump to any conclusion.
Details on the Latest Debt Restructuring Plan
In its latest attempt to stay afloat and improve its financials, CVNA announced yesterday that it is offering its creditors an option to exchange their unsecured notes at a premium to current trading prices for new secured notes backed by collateral. The offer is for exchanging as much as $1 billion of bonds, including a condition that at least $500 million existing notes be validly tendered.
The exchange will push back repayment on some obligations to 2028 from as early as 2025. It will also help in “reducing Carvana’s cash interest expense and maintaining significant flexibility,” per the company.
The company is offering to swap five series of bonds, maturing between 2025 and 2030. Per Financial Times, “if fully subscribed, the exchange offer to existing creditors would reduce the face value of its outstanding $5.7 billion of unsecured bond debt by $1.3 billion and its annual cash interest bill by roughly $100 million. If fully subscribed, $1 billion of secured bonds would replace $1.3bn of unsecured debt.”
Is the Worst for Carvana in Rearview Mirror?
Carvana belongs to a highly cyclic industry. Given an unfavorable macro-environment, including rising interest rates, inflation-weary customers and growing recessionary fears amid the banking crisis, it will continue to be a tough road for the company.
While the company is expecting improvement in EBITDA thanks to operational efficiency, it expects retail units sold in the first quarter of 2023 to be between 76,000 and 79,000 units, down from 105,185 in the year-ago period. Consequently, total revenues are envisioned in the range of $2.4-$2.6 billion, implying a decline from $3.5 billion achieved in the first quarter of 2022. Demand for used cars is expected to drop in 2023 due to economic uncertainty and affordability issues, and if that comes true, Carvana's business will remain challenged this year as well.
Indeed, Carvana’s plans to restructure its debt load have managed to pacify investors a bit. But if Carvana is unable to fix its operations quickly and restructure the debt load successfully, the possibility of bankruptcy may rise, especially in the event of a recession.
Although Carvana is now trading at a fraction of its 2020 levels, it might not be a buying opportunity just yet. Yes, the company is trying to get on the right track but macro-economic headwinds remain and there’s only so much that the firm’s cost-saving initiatives can do. It’s better to wait on the sidelines and track the company’s progress on meeting its goals for now.
Carvana would need to demonstrate tangible progress through 2023 if it wants to get into the good books of investors again. Till then, the cautious and prudent investors should employ a “wait and see” approach on CVNA stock.
Zacks Rank & Key Picks
Carvana currently carries a Zacks Rank #3 (Hold).
If you wish to invest in the auto retail space, here are two Zacks Rank #2 (Buy) companies with strong fundamentals that can help you reap handsome profits.
AutoNation AN: AutoNation is one of the world's largest automotive dealers. Its first-quarter 2022 results marked the eighth consecutive quarter of record-high numbers. A diversified product mix, strong footprint, a large dealer network and aggressive store expansion efforts are set to fuel the firm's profitability. The acquisition of Peacock Automotive Group and Priority 1 have buoyed AutoNation’s portfolio. Enhanced digital solutions have helped AutoNation to further boost profitability and market presence.
The Zacks Consensus Estimate for AN’s 2023 earnings has moved north by 60 cents in the past 30 days. The company surpassed earnings estimates in three of the trailing four quarters and missed once, with an average surprise of 4.7%. AutoNation currently boasts a Value Score of A.
Penske Automotive PAG: Penske is riding high on strategic acquisitions. It has become the largest dealership group for Freightliner in North America with Warner Truck Centers buyout. The buyouts of Kansas City Freightliner, McCoy and Team Trucks Centers are boosting Penske’s top line. Last year, the company completed acquisitions that represent more than $1.3 billion in annualized revenues. Expansion of digital capabilities, balance sheet strength and investor-friendly moves are other positives.
The Zacks Consensus Estimate for PAG’s 2023 earnings has moved north by 23 cents in the past 30 days. The company surpassed earnings estimates in the last four quarters, with an average surprise of 11%. Penske currently boasts a Value Score of A.
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