Carvana Co. (NYSE:CVNA), the used car dealer that quickly rose to fame with its unique car vending machines, came under pressure last year as cracks appeared in its growth story. The company, however, has made a strong comeback this year, with its stock rising more than 800%, but this stellar performance is masking the underlying troubles the company is facing today.
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Aided by a possible short-squeeze, Carvana stock is likely to trend higher in the short term, but long-term-oriented investors will have to pay close attention to the company’s financial position before investing in the company today. I am bearish on the prospects for Carvana as I believe its $7.4 billion+ market value fails to accurately reflect the company’s economic reality.
The Short-Squeeze Potential
According to data from Fintel, Carvana’s short interest is close to 41.5 million shares, which represents 55% of the company’s total float. Accordingly, Carvana is the second most shorted company in the U.S., according to Yahoo Finance. Empirical evidence suggests short sellers panic even when the underlying security moves higher by just a few basis points as it could trigger margin calls.
Because of this, short sellers tend to aggressively buy the shorted asset to avoid forced closure of their position, and this could trigger a market rally in the shorted stock. This phenomenon is commonly referred to as a short squeeze.
Carvana stock has risen close to 100% in the last 30 days, and this substantial movement is likely to have already forced many short sellers to cover their positions.
Troubles Under the Hood
The recent stock market rally has masked some of the major obstacles Carvana is facing today.
First, the used car market in the U.S. may come under pressure in the remainder of this year, compressing Carvana’s margins substantially. One of the major reasons behind Carvana’s 90%+ decline in market value in 2022 was the sharp decline in used car prices in the United States. Things took a turn for the better in the first quarter of this year, with prices recovering.
However, in June, the Manheim Used Vehicle Value Index dropped by 10.3% year-over-year to 215.1. Compared to May, the index declined by 4.2% in June, making it the worst June on record for used car prices and also the largest decline since the start of the pandemic. This reversal in fortunes for the used car market will directly impact Carvana’s profitability.
Second, Carvana’s massive debt burden is likely to haunt its future and possibly lead to bankruptcy as well. In the first quarter, Carvana’s interest expenses totaled $159 million, a notable increase from just $64 million a year ago. This increase came on the back of a near-doubling of its long-term debt in this period. At the end of Q1, Carvana’s long-term debt stood at $6.28 billion compared to just $3.03 billion in Q1 2022.
The company is still burning cash from its operations and ended the quarter with $800 million in cash and short-term investments. Assuming interest expenses will exceed $500 million in 2023 and continued cash burn from business operations, Carvana will likely have to tap into debt and equity markets to remain solvent. Failure to secure necessary funding could lead to a catastrophic collapse, which is why investors should not ignore the bankruptcy risk.
Carvana failed to lure bondholders to exchange existing bonds for longer-dated notes just last month, which is an indication of creditors’ lack of willingness to believe in the long-term prospects of the company.
Also, CVNA announced a bond exchange offer in March to exchange existing bonds for up to an aggregate principal amount of $1 billion with new 9% cash or 12% payment-in-kind senior secured notes due 2028. Company filings show that bonds offered for exchange included $500 million in senior notes due 2025, which suggests the company was attempting to free up much-needed cash by extending the maturity to avoid a credit crunch.
This exchange offer was conditional upon meeting a minimum threshold of $500 million, which the company failed to achieve as bondholders remained reluctant to go for longer-dated bonds with the company, probably because of the uncertainty surrounding Carvana’s cash flows.
Third, Carvana’s focus has shifted from growth at any cost to survival, which is evident from how the company is cutting costs today while offloading inventory to improve its liquidity profile. These are necessary measures to safeguard the interests of long-term shareholders, but a lack of focus on growth might lead to undesirable outcomes in the future as competitors such as AutoNation, Inc. (NYSE:AN) are aggressively pursuing growth opportunities, potentially creating competitive advantages.
Is Carvana a Buy, According to Wall Street Analysts?
After reporting first-quarter earnings, Carvana issued bullish guidance for the second quarter, improving investor sentiment toward the stock. However, Bank of America (NYSE:BAC) analyst Nat Schindler was not entirely impressed with this positive guidance and cited concerns about the company’s financial health. The analyst went on to predict that Carvana will run out of easily and cheaply-available cash by the end of the year without another cash infusion.
Based on the ratings of 16 Wall Street analysts, Carvana has a Hold consensus rating, and the average Carvana stock price target is $16.64, which implies downside risk of 60.2% from here.
Takeaway: Carvana Stock Carries More Risk Than Reward
Carvana stock has made a remarkable comeback this year, but the company continues to face several existential threats. Although a potential short squeeze may push the stock price higher in the short term, the company’s financial struggles are likely to come into the spotlight in the long run, exerting pressure on its stock price. Investing in Carvana today seems to carry more risk than reward.
