Ernie Garcia, CEO, Carvana
Scott Mlyn | CNBC
Carvana CEO Ernie Garcia III regularly tells Wall Street that “the march continues” on the company’s mission to become the world’s largest and most profitable used-car retailer.
Its share price has also risen this year, just in the wrong direction for investors. In six months, Carvana has gone from Wall Street’s favorite used-car retailer, poised to capitalize on a robust market, to trading like a volatile meme stock amid cost-cutting measures and layoffs.
The Arizona-based used-car retailer’s fall from grace, including a nearly 90% drop in its share price since November, stems from a mix of changing market conditions and self-inflicted hurt. Many traditional dealers continue to report record or near-record results, shedding more light on Carvana’s issues.
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 analysts are worried about the company’s liquidity, rising debt and growth, which this year is expected to be the slowest since it became a public company in 2017.
“By the company’s own admission, it accelerated growth at precisely the wrong time in a consumption slowdown, leaving a major mismatch between capacity and demand, creating a cash crunch,” Morgan’s Adam Jonas said. Stanley in a note to investors earlier this month, downgrading the company and lowering its price target to $105 per share from $360.
The slowdown is due to high vehicle prices, rising interest rates and fears of recession, among other factors. Carvana bought a record number of vehicles last year amid sky-high prices and rising inflation, in anticipation of unprecedented demand which has since slowed.
Analysts say Carvana is far from out, but he may have peaked. There are concerns about the used vehicle market going forward as well as its near-term risks that outweigh the potential rewards.
“Deteriorating capital market conditions and worsening trends in the used vehicle industry have eroded our belief in Carvana’s path to securing the capital necessary to achieve sufficient scale and self-financing status. “said Scott W. Devitt of Stifel last week in an investor note. .
Carvana stock is rated “hold” with a price target of $89.30 per share, according to analyst estimates compiled by FactSet.
“We weren’t prepared”
Carvana’s stock was over $300 a share before the company released its third-quarter results on November 4, when it fell short of Wall Street earnings expectations and internal operational issues caused been revealed.
Garcia, who is also chairman, told investors that the company could not meet customer demand, which prevented it from offering its entire fleet of vehicles on its website to consumers. He said it was the result of the company buying vehicles at a higher rate than it could process.
“We weren’t prepared for this,” said Garcia, who co-founded the company in 2012 and grew it into a nearly $13 billion business.
To help with future vehicle purchase throughput and turnaround times, Carvana announced on February 24 a definitive agreement to buy the U.S. operations of Adesa – the second-largest supplier of wholesale vehicle auctions in the country – from KAR Global for $2.2 billion.
Garcia, at the time, said the deal “solidifies” Carvana’s plan to become “the largest and most profitable automotive retailer.” Ending his prepared remarks with investors for his fourth quarter results the same day with “the march continues.”
The deal was welcomed by investors, who drove the stock up 34% over the next two days to more than $152 per share. It has followed a steady decline due to recession fears and other macro trends impacting the used car market.
Expensive inventory overloaded
The gains from the deal were short-lived due to the macroeconomic environment and the company largely missing Wall Street’s expectations for the first quarter, triggering a sell-off of the company’s shares and a slew of downgrades by the analysts.
The company has been criticized for spending too much on marketing, which included a lackluster 30-second Super Bowl ad, and failing to prepare for a potential slowdown or drop in sales. Carvana says he overprepared for the first quarter, having been underprepared for demand last year.
“We built for more than what appeared,” Garcia said in an April 20 earnings call.
The results sent stocks falling over the next week. Garcia described the issues as “transient” and something the company will learn from. He admitted that Carvana may have prioritized growth over earnings as the company pushed back “a few quarters” from plans to achieve positive earnings before interest and tax.
The stock was hit again in late April, when the online used-car dealership struggled to sell bonds and was forced to turn to Apollo Global Management for $1.6 billion to save the financing agreement of the Adesa agreement.
Analysts rate the deal to finance the purchase of Adesa as “unfavourable”, at a rate of 10.25%. Its existing bonds were already yielding more than 9%. Bloomberg News reported that Apollo saved the deal after investors demanded a yield of around 11% on a proposed $2.275 billion junk bond and around 14% on a $1 billion favorite coin. .
Adverse conditions will “inevitably delay the path” to positive free cash flow for the company through 2024, Wells Fargo analyst Zachary Fadem said. In a May 3 note to investors, he downgraded the stock and reduced his price target from $150 to $65 per share.
RBC Capital Markets’ Joseph Spak expressed similar concerns about the deal, saying the integration “could be messy” over the next two years. He also downgraded the stock and lowered his price target.
“While Adesa’s strategic rationale makes sense, in our view, the modernization and staffing of 56 facilities over the next two years risks facing a prolonged period of operational inefficiency with up to 18 to 24 months of net risk ahead,” he said in a note to investors early last month.
Last week, Carvana shares hit a two-year low before surging as much as 51% on the same day with “meme stocks” such as GameStop and AMC.
Meme stocks refer to a select few stocks that suddenly gain popularity on the internet and result in exorbitant prices and unusually high trading volume.
For example, Carvana’s trading volume on Thursday was over 41.7 million, compared to a 30-day average volume of around 9 million. Trading in Carvana shares on Thursday was halted at least four times.
Nearly 29% of Carvana shares available for trading are sold short, according to FactSet, among the highest ratios in US markets.
Carvana is trying to get back into Wall Street’s good graces. In an investor presentation released late Friday, the company defended the Adesa deal and updated its growth and cost-cutting plans, including cutting its vehicle acquisition costs.
The company said it is refocusing its three key priorities: growing retail units and revenue, increasing total gross profit per unit, and demonstrating operating leverage.
“We have made significant progress on the first two goals,” the company said. However, he said he needed to do more, including on profitability, free cash flow and selling, general and administrative expenses.
The company, in the presentation, confirmed last week that it had cut 2,500 employees, or about 12% of its total workforce, and that Carvana’s management team would forgo salaries for the rest of the year in order to to contribute to the severance pay of dismissed employees.
Rivals Record Profits
Carvana’s recent troubles come as the country’s largest state-owned dealership groups continue to post record or near-record profits amid low inventory and high prices.
The nation’s largest auto retailer, AutoNation reported record first quarter earnings of $5.78 per share last month. The company has aggressively shifted to used vehicles amid a decline in the availability of new vehicles during the coronavirus pandemic. Revenue from its used car business rose 47% for the quarter, bringing its overall revenue to nearly $6.8 billion.
Lithia Motors, which is in the midst of an aggressive growth plan to become the nation’s largest vehicle retailer, said its profit more than doubled in the first quarter from a year earlier to 342, $2 million. Average gross profit per unit for used vehicles — a statistic closely watched by investors — rose 32% to $3,037. That compares to Carvana at $2,833.
“Carvana seems to have gotten a lot of that tech stock halo that Tesla also enjoyed for a long time,” said Morningstar analyst David Whiston, who covers major publicly traded dealer groups, but not Carvana. “I think that was maybe a bit generous from the market.”
–CNBC Michael Bloom and Hannah Miao contributed to this report.