Carvana Has a Difficult Uphill Climb After a Series of ‘Engine’ Problems

Last week, Carvana (CVNA) , the online used-car selling platform, released a terrible quarter. In a research note on Monday, J.P. Morgan called it “a confidence shattering quarter” and reduced their price target to $85 from $140. The analyst has concerns over operational hiccups, higher cash burn, demand uncertainty, and added debt load.

Although the stock has fallen more than 75% from its highs, CVNA is still a stock to avoid.

To bolster the balance sheet and for general corporate purposes, Carvana raised $1.25 billion in a secondary offering of 15.65 million shares priced at $80. On the plus side, the founder and CEO, Ernie Garcia III, and his father, Ernest Garcia II, purchased about a third of the deal. Nonetheless, the offering diluted shareholders by around 8% after the company racked up huge losses.

This unsettling move is reminiscent of Peloton’s (PTON) secondary in the wake of its dramatic fall from the highs.

Carvana’s business model comes into question owing to the company’s inability to turn a profit during strong demand and solid used-car prices. The widely followed short-seller Jim Chanos disclosed his fund recently shorted the stock.

Chanos noted Carvana burned $800M in cash this past quarter prior to any inventory build. In an interview, Chanos asks Carvana, “If not now, when? Meaning that if you didn’t make money when all the stars aligned for your particular business model. The model just didn’t make money in the greatest of all circumstances. What will happen when things get tougher from a systematic point of view?”

Chanos thinks this “utter disaster” of an earnings report is the first indication of the company’s results when the environment for used cars faces some difficulties. He added, “It’s now a growth stock that stopped growing. It’s had flat units for four quarters.”

Carvana has a pending acquisition of ADESA, a physical auction business for used cars and other vehicles. J.P. Morgan does see this as a good strategic fit that ought to give it a long-term competitive advantage. However, they question whether Carvana’s overall business model is actually superior or disruptive to the market, as well-capitalized bricks-and-mortar dealers will also find ways to grow and generate solid returns in an increasingly competitive environment.

Evercore ISI downgraded Carvana after earnings, lowering their price target to $110, citing the lack of visibility on expenses, the surprise equity raise, and ongoing auto shortage demand headwinds. The analyst issued a mea culpa for his ill-timed upgrade in February. They do, however, also see long-term positives from the ADESA purchase.

Another risk for Carvana is the low credit rating of its debt in a rising interest rate environment. The company faces paying sharply higher interest rates on new bond issuance for the $6+ billion of net debt with a CCC rating. Currently, the 4.875% senior unsecured bonds with a maturity of seven years are trading at 77 cents on the dollar, reflecting a yield of over 9%. Only six months ago, these same bonds were trading at par.

Carvana has an uphill climb to prove to Wall Street that its business model works in generating profits over the long term. The stock is one to avoid, especially in a market unforgiving of profitless tech-related businesses.