Why investors jumped off the Carvana train

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Ernie Garcia, CEO, Carvana

Scott Mlyn | CNBC

DETROIT – Last year, carvana CEO and co-founder Ernie Garcia took a lap of honor.

He touted the company’s “historic” second-quarter results on Aug. 5, 2021, which included the used-car retailer’s first-ever quarterly net profit. He went on to discuss the rapid growth of “a group of ambitious kids with a shocking amount to learn” at a Fortune 500 company.

It is now clear that business leaders have even more to learn. Carvana’s fairytale rise has since turned into a nightmare for investors amid rising interest rates, inflation and self-inflicted hurt.

Since Garcia’s comments last year, the company’s shares have fallen from an all-time high of nearly $377 per share, reached in August last year after that remarkable quarter, to as low as $6.50. dollars per share this week, a decline of 98%. Carvana fell from a market capitalization of $60 billion to $2.2 billion after a small rally that ended this week.

The stock gained more than 30% on Thursday, followed by a 19% rise to $11.88 per share on Friday amid a broader market rally and a possible squeeze from short sellers.

But there has been a steady string of bad news and financial results since the stock’s peak, raising concerns among investors about the company’s long-term trajectory. It also has little cash and $6.3 billion in debt, including $5.7 billion in senior notes.

Carvana has consistently borrowed money to cover losses and growth initiatives, including a $2.2 billion cash acquisition earlier this year of ADESA’s physical auction business in the United States. near KAR global.

“We believe CVNA is far from out of the woods as even when the industry bottoms out, we don’t see a V-shaped recovery,” JPMorgan analyst Rajat Gupta wrote in a note to the media. investors on Tuesday. The company reduced its earnings and free cash flow projections for the business.

Morgan Stanley withdrew its rating and price target for the stock last week. Analyst Adam Jonas cited the deteriorating used-car market and a volatile financing environment for change.

Management errors

Carvana has seen exponential growth during the coronavirus pandemic, as buyers have turned to buying online rather than visiting a dealership, with the promise of hassle-free selling and buying of vehicles used at a customer’s home.

But Carvana didn’t have enough vehicles to meet increased consumer demand or the facilities and employees to process the vehicles it had in stock. This led Carvana to buy ADESA and a record number of vehicles amid exorbitant prices as demand slowed due to rising interest rates and fears of recession.

“We built for more than what appeared,” Garcia said in an April 20 earnings call – sending the stock down 37% over the following week.

During its first-quarter earnings report, the company was criticized for spending too much on marketing, which included a lackluster 30-second Super Bowl ad, and for not preparing for a slowdown or decline in sales.

Debt

And then there’s Carvana’s debt.

The company’s bonds hit all-time lows this week as it burns cash and faces rising borrowing costs.

The Wall Street Journal reported Wednesday that the company’s long-term bonds have fallen to distressed levels, with some now trading as low as 33 cents on the dollar. The yield on their 10.25% notes was over 30% on Tuesday, according to MarketAxess, a sign that Carvana would currently find it difficult to borrow in the bond markets.

Morgan Stanley cited the company’s debt and uncertain funding outlook to pull its rating and price target for the stock. Jonas said “a deterioration in the used car market combined with a volatile interest rate/funding environment” posed a “significant risk” to the company.

Jonas issued a new base case range for Carvana of between $1 per share and $40 per share over the next 12 months.

Price pressures

The used car market is on track to end the year down more than 12% from the 40.6 million used vehicles sold in 2021, according to mid-October estimates from Cox Automotive. Carvana’s sales in the third quarter of this year were up 4% from 2021, but were much less profitable than a year earlier and were lower quarter over quarter.

Carvana’s third-quarter sales were down 8% from a year earlier, while earnings per vehicle sold fell 25% to $3,500. CEO Garcia described the end of the third quarter as “the most unaffordable point ever” for customers financing a vehicle purchase.

“Carvana has succeeded in disrupting the automotive industry with a proven e-commerce model serving millions of happy customers, and although the current environment and market have brought short-term attention, we have continued to win. market share in the third quarter and we remain focused on our plan to drive profitability, while making the best car buying and selling experience even better,” a company spokesperson said in a statement. .

Used car prices down 2.4% since last month

The declines came amid falling wholesale prices for new vehicles. The Manheim Used Vehicle Value Index, which tracks the prices of used vehicles sold at its wholesale auctions in the United States, fell 15.4% this year through October after peaked in January, including a 2.2% drop from September to October.

Retail prices traditionally follow the evolution of wholesale prices. That’s good news for potential car buyers, but not for companies like Carvana who bought the vehicles at record prices and are now trying to sell them for a profit.

Used vehicle prices have held steady so far, but that may not last long as wholesale costs continue to fall.

“They don’t want to sell at low prices,” said Chris Frey, senior industry intelligence manager at Cox Automotive. “That’s why we don’t see prices dropping that much at retail.”

Affordability

Frey noted that vehicle affordability continues to decline, with auto loan rates hitting a 15-year high, even as prices have fallen slightly. The average listing price for a used vehicle is stabilizing but still near record highs of over $28,200, according to Cox Automotive.

“We’ve seen a drag effect in retail sales, and a lot of that has to do with affordability,” Frey said. “The affordability, married to those higher prices, is starting to have an effect on sell rates.”

The competition is also catching up with Carvana. During the coronavirus pandemic, franchise vehicle dealerships such as AutoNation were forced to start selling vehicles online as showrooms closed and consumers stayed away from dealerships. Carvana’s traditional rivals have started delivering on their same promise of hassle-free online car buying.

“They took a lot, almost all, of the air from the balloon for Carvana,” Frey said.

– CNBC’s Michael Bloom contributed to this report.

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