Why investors have jumped off the Carvana bandwagon

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

He touted the company’s “landmark” second-quarter results on Aug. 5, 2021 that included the used car retailer’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’s now apparent the company’s executives still have more to learn. Carvana’s fairytale rise has since turned into a nightmare for investors amid rising interest rates, inflation and self-inflicted wounds.

Since Garcia’s comments last year, shares of the company have fallen from an all-time high of nearly $377 per share, notched in August of last year after that standout quarter, to as little as $6.50 per share this week – a 98% decline. Carvana has plummeted from a market cap of $60 billion to $2.2 billion after a small rally to end this week.

The stock gained more than 30% on Thursday, followed by a 19% increase to $11.88 per share Friday amid a broader market rally and possible short-seller squeeze.

But it’s been a steady run of bad news and financial results since the stock’s peak, stirring concerns among investors 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 an all-cash $2.2 billion acquisition earlier this year of ADESA’s U.S. physical auction business from KAR Global.

“We believe CVNA is far from out of the woods, as even when the industry bottoms out, we don’t see a V-shaped recovery,” JPMorgan analyst Rajat Gupta wrote in a Tuesday note to investors. The firm cut its projections for earnings and free cash flow for the company.

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

Carvana grew exponentially during the coronavirus pandemic, as shoppers shifted to online purchasing rather than visiting a dealership, with the promise of hassle-free selling and purchasing of used vehicles at a customer’s home.

But Carvana did not have enough vehicles to meet the surge in consumer demand or the facilities and employees to process the vehicles it did have in stock. That led Carvana to purchase ADESA and a record number of vehicles amid sky-high prices as demand slowed amid rising interest rates and recessionary fears.

“We built for more than showed up,” Garcia said during an earnings call April 20 – sending the stock down by 37% through the following week.  

During its first-quarter earnings report, the company was 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 downturn in sales.

And then there’s Carvana’s debt.

The company’s bonds touched all-time lows 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 declined to distressed levels, with some now trading as low as 33 cents on the dollar. The yield on their 10.25% notes was over 30% as of Tuesday, according to MarketAxess, a sign that Carvana would struggle to borrow from bond markets presently.

Morgan Stanley cited the company’s debt and uncertain funding outlook in pulling its rating and price target for the stock. Jonas said “a deterioration in the used car market combined with a volatile interest rate/funding environment” made for a “material risk” to the company.

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

The used car market is on pace to finish the year down more than 12% from the 40.6 million used vehicles sold in 2021, according to mid-October estimates from Cox Automotive. Carvana’s sales through the third quarter of this year were up 4% over 2021, but were far less profitable than a year earlier and were lower on a quarter-over-quarter basis.

Carvana’s third-quarter sales declined 8% from a year earlier, while profits per vehicle sold plummeted 25% to $3,500. CEO Garcia described the end of the third quarter as the “most unaffordable point ever” for customers who finance a vehicle purchase.

“Carvana successfully disrupted the auto industry with a proven ecommerce model serving millions of satisfied customers, and although the current environment and market has drawn attention to the near-term, we continued to gain market share in Q3, and we remain focused on our plan to drive to profitability, while making the best car buying and selling experience available even better,” a company spokesperson said in a statement.

The declines have come amid falling wholesale prices of new vehicles. The Manheim Used Vehicle Value Index, which tracks prices of used vehicles sold at its U.S. wholesale auctions, has fallen by 15.4% this year through October after peaking in January, including a 2.2% decline from September to October.

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

Used vehicle prices have so far remained steady, but that may not last long, as the wholesale costs continue to decline.

“They’re not wanting to sell at trough prices,” said Chris Frey, senior industry insights manager at Cox Automotive. “That’s why we’re not seeing the prices decline so much at retail.”

Frey noted that vehicle affordability continues to decline, with auto loan rates reaching a 15-year high even though prices declined slightly. The average used listing price for a used vehicle is stabilizing but remains near record highs of more than $28,200, according to Cox Automotive.

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

The competition also is catching up to Carvana. During the coronavirus pandemic, franchised vehicle dealers such as AutoNation were forced to begin selling vehicles online while showrooms shuttered and consumers stayed away from dealerships. Carvana’s traditional rivals began delivering on its same promise of hassle-free online car purchasing.

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

–CNBC’s Michael Bloom contributed to this report.