Why investors jumped off the Carvana bandwagon

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Ernie Garcia, CEO, Carvana

Scott Mlyn | TBEN

DETROIT – Last year, Carvana CEO and co-founder Ernie Garcia went on a victory lap.

On August 5, 2021, he touted the company’s “landmark” for its second quarter, including the used-car seller’s first-ever quarterly net profit. He then reminisced about the rapid growth of “a bunch of ambitious kids with a shocking amount to learn” into a Fortune 500 company.

It is now clear that the company’s executives still have more to learn. Carvana’s fairytale rise has since turned into an investor’s nightmare amid rising interest rates, inflation and self-inflicted wounds.

Since Garcia’s comments last year, the company’s stock has fallen from a record high of nearly $377 a share, reached in August last year after that standout quarter, to just $6.50 a share this week — a 98% drop. . Carvana has plunged from a market cap 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% gain to $11.88 a share Friday amid a broader market rally and potential short-selling short sellers.

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

Carvana has consistently borrowed money to cover its losses and growth initiatives, including a $2.2 billion cash acquisition earlier this year of ADESA’s physical auction business in the US of CAR Worldwide.

“We believe CVNA is far from out of the blue because even if the industry bottoms out, we won’t see a V-shaped recovery,” JP Morgan analyst Rajat Gupta wrote in a note to investors on Tuesday. The company lowered its forecasts for earnings and free cash flow for the company.

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

Management missteps

Carvana grew exponentially during the coronavirus pandemic, as shoppers switched to purchasing online rather than visiting a dealer, promising hassle-free sales and purchases of used vehicles at a customer’s home.

But Carvana did not have enough vehicles to meet strong consumer demand or the facilities and employees to process the vehicles it did have in stock. That prompted Carvana to buy ADESA and a record number of vehicles at skyrocketing prices as demand slumped amid rising interest rates and fears of a recession.

“We’ve built for more than we’ve shown,” Garcia said during an April 20 earnings call, which saw the stock plunge 37% the following week.

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

Debt

And then there’s Carvana’s fault.

The company’s bonds hit an all-time low 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 for just 33 cents on the dollar. According to MarketAxess, the yield on their 10.25% notes was above 30% Tuesday, a sign that Carvana would currently struggle to borrow from the bond markets.

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Morgan Stanley cited the company’s debt and uncertain financing prospects in drawing its rating and price target for the stock. Jonas said that “a deterioration in the used car market coupled with a volatile interest rate/financing environment” posed a “material risk” to the company.

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

Price pressure

The used car market is on track to close the year at more than 12% less than the 40.6 million used vehicles sold in 2021, according to estimates by Cox Automotive in mid-October. 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 on a quarterly basis.

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 priceless moment ever” for customers financing the purchase of a vehicle.

“Carvana has successfully disrupted the automotive industry with a proven e-commerce model serving millions of satisfied customers, and while the current environment and market has drawn attention in the near term, we continued to gain market share in the third quarter, and we continue to focused on our plan to be profitable while making the best experience for buying and selling cars even better,” a company spokesperson said in a statement.

Used car prices down 2.4% since last month

The decreases are the result of falling wholesale prices of new vehicles. The Manheim Used Vehicle Value Index, which tracks the prices of used vehicles sold in its U.S. wholesale auctions, is down 15.4% this year through October after peaking in January, including a 2.2% decline in September to October.

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

Used vehicle prices have remained stable so far, but that won’t last long as wholesale costs continue to fall.

“They don’t want to sell at rock bottom prices,” said Chris Frey, Senior Industry Insights Manager at Cox Automotive. “That’s why we don’t see retail prices drop that much.”

affordability

Frey noted that auto affordability continues to fall, with auto loans hitting the highest level in 15 years, although prices fell slightly. The average used price for a used vehicle is stabilizing but remains near all-time highs of more than $28,200, according to Cox Automotive.

“We’re seeing a slowdown effect in retail sales, and a lot of it has to do with affordability,” Frey said. “The affordability aspect, combined with these higher prices, is starting to have an effect on sales.”

The competition also overtakes Carvana. During the coronavirus pandemic, franchise dealers such as: AutoNation were forced to sell vehicles online, while showrooms closed their doors and consumers stayed away from dealers. Carvana’s traditional rivals began to deliver on the same promise of hassle-free online car purchases.

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

– TBEN’s Michael Bloom contributed to this report.

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