Ernie Garcia, CEO of Carvana

Scott Mill CNBC

Carvana CEO Ernie Garcia III regularly tells Wall Street that the “march continues” in the company’s mission to become the world’s largest and most lucrative seller of used cars.

The price of its shares also went this year, only in the wrong direction for investors. Within six months, Carvana had moved from a preferred used car seller on Wall Street, ready to make money in a sustainable market, to trading as a volatile meme stock amid cost-cutting measures and layoffs.

The drop for used car retailers in Arizona, including a nearly 90% drop in stock value 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, shedding further light on Carvana’s concerns.

Carvana grew exponentially during the coronavirus pandemic, when shoppers switched to shopping online rather than visiting a dealership, with the promise of hassle-free sales and buying used cars at a customer’s home. But analysts are concerned about the company’s liquidity, debt growth and growth, which this year is expected to be the slowest since becoming a company in 2017.

“By the company’s own admission, it accelerated growth at the wrong time, resulting in a consumer slowdown, resulting in a serious mismatch between power and demand, creating liquidity cuts,” said Adam Jonas of Morgan Stanley in an investor note earlier this month, lowering the rating. companies and lower the target price to $ 105 per share from $ 360.

The slowdown is due to high vehicle prices, rising interest rates and fears of a recession, among other factors. Last year, Carvana bought a record number of cars amid sky-high prices and rising inflation, preparing for unprecedented demand, which has since slowed.

Analysts say Carvana is still a long way off, but perhaps it has reached its peak. There are concerns about the used car market as well as risks in the near future that outweigh the potential benefits.

“Deteriorating capital market conditions and deteriorating trends in the used car industry have shattered our belief that Carvana can provide the necessary capital to realize sufficient scale and self-financing status,” Scott W. Devitt of Stifel said in an investor note last week. .

According to analysts, compiled by FactSet, Carvana shares have a rating of “content” with a target price of $ 89.30 per share.

“We were not prepared”

Shares of Carvana were at more than $ 300 per share, ahead of the third-quarter results report on Nov. 4, when it did not meet Wall Street earnings expectations and internal operating problems were revealed.

Garcia, who also holds the chairmanship, told investors that the company could not meet customer demand, with the result that it did not offer its entire fleet of vehicles on its website for purchase by consumers. He said it was a result of the company purchasing vehicles at a higher rate than it could handle.

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

To help with future car purchases and resumption, Carvana announced on February 24 a final deal to buy Adesa, the country’s second-largest wholesaler of car auctions, from KAR Global for $ 2.2 billion.

At the time, Garcia said the deal “solidifies” Carvana’s plan to become “the largest and most profitable automotive retailer.” Concluding the prepared statements of investors regarding the profits in the fourth quarter on the same day, “the march continues.”

The deal was welcomed by investors, who over the next two days increased shares by 34% to more than $ 152 per share. It has followed a steady decline due to fears of recession and other macroeconomic trends affecting the used car market.

Rebuilt expensive inventory

Profits from the deal were short-lived due to macroeconomic conditions and the company significantly missed Wall Street expectations in the first quarter, triggering a sell-off of the company’s shares and numerous downgrades by analysts.

The company was criticized for spending too much on marketing, which included a dim 30-second Super Bowl ad, and not preparing for a potential slowdown or declining sales. Carvana claims it was over-prepared for the first quarter after last year was under-prepared for demand.

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

The results of the stock fell in price over the next week. Garcia described the problems as “transitional” and something the company would learn from. He acknowledged that Carvana may have prioritized growth over profits as the company pushed back plans to achieve positive profits before calculating interest and taxes for “several quarters”.

Shares collapsed again in late April when an online used car dealer struggled to sell the bonds and was forced to turn to Apollo Global Management for $ 1.6 billion to save a deal to finance the Adesa deal.

Analysts consider the deal to finance the purchase of Adesa “unprofitable” at 10.25%. Its existing bonds have already yielded more than 9%. Bloomberg News reported that Apollo saved the deal after investors demanded a return of about 11% on proposed bonds worth $ 2.275 billion and about 14% on preferred bonds worth $ 1 billion.

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

RBC Capital Markets spokesman Joseph Spock expressed similar concerns about the deal, saying integration could “be messy” over the next two-plus years. It also downgraded the stock rating and lowered the target price.

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

Memo status

Last week, Carvana shares hit a two-year low before rising 51% on the same day along with “meme stocks” such as GameStop and AMC.

Memo promotions are several promotions that are suddenly gaining popularity on the Internet and lead to sky-high prices and unusually high trading volumes.

For example, Carvana’s trading volume on Thursday was more than 41.7 million compared to an average volume of 30 million in 30 days. On Thursday, trading in Carvana shares stopped at least four times.

According to FactSet, nearly 29% of Carvana’s available-for-sale shares sold in the short term are one of the highest in U.S. markets.

Carvana is trying to return to the good graces of Wall Street. In a presentation to investors released late Friday, the company defended the Adesa deal and updated its plans to grow and reduce costs, including reducing the cost of buying cars.

The company said it would refocus its three main priorities: increasing retail units and revenue, increasing total gross profit per unit and demonstrating operating leverage.

“We have made significant progress in achieving the first two goals,” the company said. However, he said more needs to be done, particularly in terms of profitability, free cash flow and sales, general and administrative expenses.

The company in a presentation confirmed reports last week that it had cut 2,500 employees, or about 12% of the total workforce, and that Carvana’s executive team would give up salaries for the rest of the year to contribute to severance pay.

Record earnings of rivals

Carvana’s recent problems come at a time when the country’s largest public dealer groups continue to report record or near-record profits amid low stocks and high prices.

The country’s largest auto retailer AutoNation last month reported record first-quarter earnings per share of $ 5.78. The company aggressively switched to used cars amid declining availability of new vehicles during the coronavirus pandemic. Revenue from used car business grew 47% for the quarter, bringing total revenue to nearly $ 6.8 billion.

Lithia Motors, which is in the midst of an aggressive growth plan to become the country’s largest car dealer, said its first-quarter profit more than doubled from a year earlier to $ 342.2 million. The average gross profit per unit of used cars – a statistic closely monitored by investors – rose 32% to $ 3,037. That’s compared to Carvana for $ 2,833.

“Carvana seems to have gained a lot of this halo of technology stocks, which Tesla has also enjoyed for a long time,” said Morningstar analyst David Whiston, who covers major public dealer groups but not Carvana. “I think maybe it was a little generous from the market.”

– CNBC Michael Bloom and Hannah Miao contributed to this report.

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