How Carvana went from Wall Street leader to meme stock trading

Ernie Garcia, CEO of Carvana

Scott Mlyn | CNBC

Carvana CEO Ernie Garcia III regularly tells Wall Street that the “march continues” in the company’s bid to become the world’s largest and most profitable used car dealer.

Its share price has also risen this year, but in the wrong direction for investors. Within six months, Carvana went from being Wall Street’s favorite used car dealer, poised to capitalize on a strong market, to trading like a volatile meme stock amid cost-cutting measures and layoffs.

The fall of the Arizona used-car retailer, including a nearly 90 percent decline in its share price since November, was the result of a combination of changing market conditions as well as self-inflicted wounds. Many traditional dealers continue to report record or near-record results, further shedding light on Carvana’s troubles.

Carvana has grown exponentially during the coronavirus pandemic as shoppers have moved to online shopping rather than visiting a dealership, with the promise of hassle-free selling and buying used vehicles from a customer at home. But analysts are concerned about the company’s liquidity, increased debt and growth expected to be the slowest this year since going public in 2017.

“By the company’s own admission, it accelerated growth at the worst possible time due to a slowdown in consumer demand, leaving a severe gap between capacity and demand, creating a liquidity crunch,” Morgan Stanley’s Adam Jonas said in a note to investors earlier this month, downgrading rating. company and reduce the target price to $105 per share from $360.

The slowdown is due to high car prices, rising interest rates and fears of a recession, among other factors. Carvana bought a record number of vehicles last year amid sky-high prices and rising inflation, bracing for unprecedented demand that has since slowed.

Analysts say Carvana is far from exhausted, but it may have already peaked. There are concerns about the future of the used car market, as well as its short-term risks that outweigh the potential benefits.

“Deteriorating capital market conditions and deteriorating trends in the used car industry have undermined our belief that Carvana will be able to secure the necessary capital to realize sufficient scale and self-financing status,” Stifel’s Scott W. Dewitt said last week in a note to investors. .

Carvana shares are rated Hold with a target price of $89.30 per share, according to analyst estimates compiled by FactSet.

“We weren’t ready”

Carvana’s stock was trading at more than $300 a share before the company reported its third-quarter results on November 4, when it fell short of Wall Street’s earnings expectations and internal operating problems were revealed.

Garcia, who is also chairman, told investors that the company is unable to keep up with customer demand, which is why it does not offer its entire fleet of vehicles on its website for consumers to purchase. He said this was due to the company purchasing vehicles at a higher price than it could handle.

“We weren’t ready for this,” said Garcia, who co-founded the company in 2012 and built it into a nearly $13 billion business.

Oversaturated expensive inventory

Profits from the deal were short-lived due to the macro environment, and the company fell significantly short of Wall Street’s first-quarter expectations, leading to a sell-off in the company’s stock and multiple downgrades by analysts.

The company has been criticized for spending too much on marketing. 30 second Super Bowl commercialrather than brace for a potential slowdown or drop in sales. Carvana claims it was over-prepared for the first quarter after being under-prepared for demand last year.

“We’ve built more than we’ve shown,” Garcia said during an April 20 earnings call.

The results crashed stocks over the next week. Garcia called these problems “transitory” and the company should learn from them. He acknowledged that Carvana may have prioritized growth over earnings as the company delayed plans to achieve positive earnings before interest and taxes “for several quarters.”

Stocks tumbled again in late April as the online used car dealer struggled to sell bonds and was forced to turn to Apollo Global Management for $1.6 billion to salvage a deal to finance a deal with Adesa.

Analysts view the deal to finance the purchase of Adesa as “unfavorable” at a rate of 10.25%. His existing bonds were already yielding above 9%. Bloomberg News Apollo reported saved the deal after investors demanded a yield of about 11% on the proposed $2.275 billion junk bonds and about 14% on the $1 billion preferred bonds.

Adverse conditions “inevitably delay the path” to positive free cash flow for the company until 2024, said Wells Fargo analyst Zachary Fadem. In a May 3 note to investors, he downgraded the stock and lowered his price target from $150 to $65 per share.

Joseph Spak of RBC Capital Markets expressed similar concerns about the deal, saying the integration “could be a mess” over the next two-plus years. He also downgraded the stock and lowered his target price.

“While the strategic rationale for Adesa makes sense, in our view, upgrading and staffing 56 sites over the next few years is likely to face a long period of operational inefficiency with 18-24 months of ongoing risk. he said in a note to investors early last month.

meme status

Carvana is trying to win back the favor of Wall Street. In a presentation to investors released at the end of Friday, the company defended its Adesa deal and updated its growth and cost-cutting plans, including lowering vehicle acquisition costs.

The company said it is refocusing its three key priorities: growing retail units and revenues, increasing total gross margin per unit, and demonstrating operating leverage.

“We have made significant progress on the first two challenges,” the company said. However, the company said more needs to be done, especially on profitability, free cash flow, and selling, general and administrative expenses.

The company, in a presentation, confirmed reports last week that it had cut 2,500 employees, or about 12% of its total workforce, and that Carvana’s executive team would waive payroll until the end of the year to contribute to severance pay for laid-off employees.

Competitor’s record profit

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