Buy Carvana (CVNA) on Raised Profit View or Sell the Rally?
Carvana CVNA, a pandemic-darling stock, suffered a brutal 2022 to the extent that the survival of the company was put into question. The used car e-retailer— encumbered with debt— lost 98% of its value last year due to a cocktail of unfavorable factors, including a hawkish Fed, rising used vehicle prices, elevated leverage, goodwill write-off, declining sales volumes and compressing margins.
However, in a remarkable reversal, CVNA's shares have surged an impressive 732% this year, bouncing back from last December's lows of just under $4 to hover around $40 per share presently. Carvana has recaptured investor interest by trimming costs and executing a $1.2 billion debt restructuring initiative. The first and second-quarter 2023 results of the firm indicate a promising trajectory. Investors have swiftly responded to these improvements, driving up the stock price.
As Carvana’s turnaround gains momentum, the company revised its profit expectations upward two days back. This prompts the crucial question of whether one should ride along with Carvana's newfound optimism and invest in the stock, or is it wiser to capitalize on the skyrocketing rally and book profits?
Policy Overhaul at CVNA is Bearing Fruit
Amid mounting losses, Carvana started prioritizing operational efficiency over growth. During the second quarter of 2022, CEO Ernie Garcia said, "We have shifted our priorities for the first time in company history to favor efficiency and cash flow in recognition of the changes to the market and the economic landscape, as well as to enable us to quickly adjust to changes in our industry that had caused our expenses to be out of balance with sales volumes."
Carvana incurred lower-than-expected losses in both the first and second quarters of 2023. In the last reported quarter, the company managed to achieve its goal of generating positive adjusted EBITDA and also posted a record GPU of $7,030.It does seem that management is pivoting in the right direction and the company is delivering on its promises.
Over the last three quarters, the company has achieved substantial progress in restoring its inventory levels to normalcy and effectively selling off older inventory. This has resulted in a decrease of approximately 40 days in the average days to sale (ADTS) for retail units sold during the second quarter of 2022. The trend is expected to continue into the third quarter, resulting in further reduction.
Carvana achieved a positive adjusted EBITDA of $155 million in the second quarter of 2023, thanks to operational discipline. Adjusted EBITDA margin was 5.2%, up 10.8% from second- quarter 2022 and exceeding the previous best quarter by 1.6%. Focus on more lucrative transactions, heightened operational efficiencies and effective cost-saving measures drove the results.
It should also be noted that Carvana has achieved an annualized SG&A expense reduction of more than $1.1 billion since the second quarter of 2022. The company has managed to reduce retail reconditioning and inbound transport cost reductions as a result of fundamental improvements, including in-sourcing third-party services, staffing normalization, process standardization, proprietary software development, logistics network utilization and reduced inbound transport distance.
In addition to lower reconditioning and transportation costs, expanded customer sourcing and additional revenue streams from value-added services are also driving retail GPU gains.
The acquisition of ADESA's U.S. operations has strengthened Carvana's logistics network and auction capabilities. Since the acquisition, the ADESA wholesale platform has grown, allowing Carvana to enhance efficiency in wholesale vehicle sales. CVNA is now sourcing and selling about 30% as many wholesale units as the largest U.S. dealer wholesaler, up from under 10% in 2019. As the wholesale used vehicle auction industry rebounds, there's potential for more than 50% industry unit growth from 2022 levels, offering substantial opportunities for ADESA.
Carvana’s financial situation has witnessed improvement, thanks to a debt restructuring deal. The deal aims to reduce total debt by more than $1.2 billion, extend maturities and lower near-term cash interest expenses, providing significant flexibility for the company's profitability and growth plan. More than 83% of Carvana's 2025 and 2027 unsecured note maturities will be eliminated, resulting in a cash interest expense reduction of more than $430 million annually for the next two years. As these new loans are secured by Carvana's tangible assets, these creditors have a safeguard if the company faces challenges repaying its debts and defaults. The arrangement also provides Carvana with additional room to manage any slowdown in the used car market while strengthening its financial position.
CVNA Boosts Outlook
Carvana anticipates adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) for the third quarter 2023 to surpass $75 million. The company had previously provided a "positive" outlook for adjusted EBITDA. This upward revision can be attributed to increased loan sales, operational enhancements (including cost reductions at inspection centers and the incorporation of in-sourced services) and record profit per unit in preceding quarters. The company has also lifted its forecast for total GPU in the third quarter to more than $5,500, an increase of $500 from the prior guidance.
Mark Jenkins, Carvana’s chief financial officer said, “Our strong execution is continuing to drive lasting business improvements, including significant fundamental gains in Retail and Wholesale GPU, that will power future results.”
The upgraded outlook comes just three weeks after the company reported better-than-expected second-quarter results and announced plans to restructure its debt load, thereby pacifying investors a bit.
Don’t be Hasty to Invest Just Yet
Emerging from near bankruptcy, Carvana has shown resilience but caution is warranted. The revised EBITDA forecast signals hope as the company strives to regain its lost glory. However, lest we forget, revenues are waning due to declining unit sales, with a 23.5% year-over-year drop in the last reported quarter. The decline was due to a 35% and 16% dip in retail and wholesale units sold, respectively. Notably, Carvana hasn’t upgraded its outlook for retail units sold. It foresees second-quarter 2023 retail unit sales to remain nearly stagnant, mirroring the second-quarter figures.
Also, Carvana hasn't turned an annual profit yet. The net loss has expanded annually since its 2017 IPO, reaching $462.2 million in 2020. Despite recording its first profit in second-quarter 2021, it recorded a net loss of $287 million in full-year 2021. The company hit a wall in 2022. Although the company seems to be ticking the right boxes, we anticipate it to face annual losses this year as well.
Further, the shift toward prioritizing unit economics over growth raises concerns about cost management during potential expansion. As Carvana navigates this landscape, caution needs to be exercised.
Bottom Line
While an improved EBITDA forecast signals progress, the absence of updated retail unit sales outlook, coupled with prior losses, raises concerns. Indeed, positive strides are visible but it might be premature to enter the stock's turnaround.
In fact, investors might be tempted to sell their holdings on the stock’s impressive performance this year. After all, Carvana's journey has not been an easy one, so exiting your position if you are sitting on gains may seem right.
However, if you firmly believe in Carvana's long-term potential, especially after the recent financial updates and debt restructuring, holding onto the stock might be wise. If the company records growth in units sold and revenues while gaining market share and managing expenses all at the same time, even current shareholders in the negative could eventually turn a profit.
CVNA currently carries a Zacks Rank #3 (Hold).
Better Picks From the Same Space
If you wish to invest in the auto retail space, you can consider parking your money in Group 1 Automotive GPI and Penske Automotive PAG. Both these stocks sport a Zacks Rank #1 (Strong Buy)
The Zacks Consensus Estimate for GPI’s 2023 earnings has moved north by 44 cents in the past seven days. The company surpassed earnings estimates in the last four quarters, with an average surprise of 7.9%. Penske currently boasts a Value Score of A.
The Zacks Consensus Estimate for PAG’s 2023 earnings has moved north by 52 cents in the past 30 days. The company surpassed earnings estimates in the last four quarters, with an average surprise of 6.2%. Penske currently boasts a Value Score of A.
You can see the complete list of today’s Zacks #1 Rank stocks here.
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