Carvana Stock Drops Amid Used Car Price Declines

Key takeaways

• Used car marketplace Carvana saw its stock plunge 48% in two days after abysmal third quarter earnings
• Carvana stock is down almost 97% year-to-date (YTD) as an overheated auto market finally shows signs of cooling
• While lower car prices are good for consumers, investors may take a hit as automaker profits and projections decline

Carvana stock took a massive nosedive Friday as investors fled the coupe. The online auto retailer’s stock price shed 39% in a day while trading volumes hit an all-time company record of 71 million.

After slipping an additional 18% in premarket trading Monday, the early week’s turbulent session was pockmarked by trading halts. Carvana stock closed down 15.6% Monday, reaching just $7.39 per share – half of Thursday’s $14.35 closing price.

All told, the auto seller’s share price plunged 48% in just two days, and has dropped nearly 97% YTD.

The culprit? Uncertainty surrounding a finally-declining auto market – and investor worries about Carvana’s business model following a disappointing third quarter.

What is Carvana?

Carvana is a used car dealer that combines ecommerce and vending machines to buck the traditional dealership model. Users can shop for used cars online and enjoy haggle-free pricing and at-home delivery. In some locations, shoppers can visit clear, multi-story “vending machines” that dispense vehicles to waiting customers.

Carvana aims to simplify and modernize the car buying experience. And up until the most recent quarter, its model seemed to work…mostly.

We’ll get into all that below. First, let’s take a little ride down memory lane to see why the “Amazon of car shopping” has stalled among investors.

A world of (auto) trouble

Unless you live under an engine block, you’ve probably heard about the raging inflation that’s gripped the world by the wallet.

While the causes of Covid-induced inflation are many, one could argue that the first vestiges crept in with a small, not-so-simple device: the semiconductor.

Let’s backtrack a moment.

Semiconductors and auto prices: an inextricable link

Back in 2020, car sales, like most out-of-the-house purchases, dropped dramatically. To cut their losses, auto manufacturers slashed production. Aside from declining demand for big stuff like steel and tires, they also cancelled or delayed semiconductor orders. (Cars rely on these tiny computer chips for everything from running the internal computer to turning on the lights.)

In the absence of automaker orders, and given the increased demand for higher-powered chips for computers and other electronics, many semiconductor manufacturers retooled their plants. This allowed them to transition from making auto chips, a 40-year-plus old technology, to sleeker, more modern devices.

Unfortunately, when car manufacturers kicked up production to meet rising demand in 2021, they found few manufacturers who could fill their needs. Not only that, but semiconductor orders are typically placed months in advance – so any automaker who didn’t have reserve on hand was out of luck.

Thus began the rise of auto prices. As demand soared, existing supply dwindled and chip manufacturing all but stalled, consumers turned to used cars. At one point, used vehicle prices shot up nearly 40% as dealerships struggled to keep inventory on the lot.

Unsurprisingly, as an online used car dealership, Carvana was uniquely positioned to flourish in the pandemic. Rising car prices fueled the company’s growth as sellers cashed or traded in on higher prices, while buyers snapped up inventory as fast as the company could make deals.

All good things must come to an end

But like many pandemic-era trends, Carvana’s good luck eventually dwindled.

In some areas, used car prices surged so high that the average consumer was priced out of the market entirely. Similar inflation in other industries prompted the Federal Reserve to spike interest rates to discourage spending and borrowing.

Over time, this combination has eaten into used car demand. In some cases, shoppers found themselves a few bucks short of ever-rising sticker prices. In others, consumers balked at rising interest rates on auto financing.

And as semiconductor snaggles have slowly untangled, automakers bumped up production, pushing down car prices (or at least stabilizing them) from another angle.

Together, these factors spell good news for consumers…and less good news for investors. In the last year, used car prices have dropped 10.6%, eating into dealership prices. Already, national franchises like Lithia Motors and AutoNation have reported softening market conditions.

Now, it appears financial reckoning has come for Carvana’s stock, too.

Carvana’s very bad week

It’s no surprise that a wavering used car industry would eat into a used car dealer’s profit margins. Unfortunately for Carvana stock, that’s exactly what happened.

The company’s stock decline began last Thursday after posting disappointing third quarter financial results.

Revenues came in at $3.39 billion against the $3.71 billion expected, while per-share losses amounted to $2.67. Total net losses jumped from $32 million to $282 million year-over-year.

All told, Carvana’s gross profit slumped 31% to just $359 million as retail unit sales declined 8% to 102,570 vehicles. Investors were also disappointed by the gross profit per unit, which declined over $1,100 to $3,500.

But perhaps most distressing is the company’s cash position. While Carvana’s cash and equivalents totaled $1.05 billion last year, it now claims just $316 million to its name.

Carvana management blamed affordability issues, noting that used car customers have seen monthly payments rise 160% compared to pre-pandemic numbers.

Carvana CEO and cofounder Ernest Garcia III also noted that, for customers who finance auto purchases, the end of Q3 was “the most unaffordable point ever” for shoppers. “Cars are extremely expensive, and they’re extremely sensitive to interest rates,” he said. (Carvana pointed out that the 2-year Treasury yield, up 3.9% in a year, provides a solid benchmark for auto rates.)

But Carvana’s management is positive that it can turn the ship around…at least, eventually. The company predicts that the next year will be a “difficult one” as used vehicle prices normalize and consumers adjust to interest rates. It plans to “be a better company” as a result of traversing these economically uncertain times.

CEO Garcia also added that, “While progress is rarely linear, we remain on the path to becoming the largest and most profitable auto retailer.”

Analyst rating shifts into low gear

Despite management’s optimism, one ratings downgrade in particular caught Carvana stock by the tailpipe.

Influential Morgan Stanley analyst Adam Jonas pulled his previous $68 price target for Carvana on Friday. Said Jonas in a client note: “While the company is continuing to pursue cost-cutting actions, we believe a deterioration in the used car market combined with a volatile interest rate/funding environment (bonds trading at 20% yield) add material risk to the outlook, contributing to a wide range of outcomes.”

As for just how big that outcome is, Jonas suggested that Carvana shares could dip as low as $1 or reach as high as $40.

As for Carvana stock, it’s likely that Jonas’ dour-yet-uncertain report contributed to Friday’s extreme volatility.

Good for consumers…dealerships and investors, not so much

Carvana’s fall from grace sits on the threshold of a widening trend in the used car market.

As car prices slip, consumers will breathe a collected sigh of relief. Rising interest rates and talk of a potential recession may lend further impetus to these declines.

But for investors, the news is less cheery. Lower prices and decreased demand lead to smaller profits and more cost-cutting measures, both of which make short-term investors nervous.

Carvana investors in particular may find more reason to sweat their investment.

As a used-only dealership, the company’s model depends on buying used cars for less than it sells them for. But amid declining prices, the value of any recently-purchased inventory has likely deflated, leaving smaller – or no – profit margins.

As its Q3 earnings report revealed, its per-unit profits have already shrunk over $1,100 apiece, with further degeneration likely if used car market trends continue.

Tired of Covid bets like Carvana stock? Try Q.ai instead

It’s likely that Carvana’s stock is in the midst of a short-term blip that, like used car prices, will even out with time. In that case, the company would prove that it – like many equities – is best-suited as a long-term bet. (That is, an investment you make expected to generate returns over decades, not years or months.)

In the meantime, Carvana, like many oscillating Covid-era success-cum-not-quite-failure stories (see also: Zoom, Peloton, DocuSign and even Meta and Shopify) will have to learn to grapple with the nuances of a modern market.

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