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Carvana's (CVNA) Dramatic Crash is NOT a Buying Opportunity

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It’s no secret that the auto space has suffered one of the worst blows from the supply-chain snafus and microchip dearth. The industry is indeed going through a rough patch with manufacturers struggling with the suspension of operations, delays in the launch of new models and rising commodity costs. Retailers are also feeling the pinch amid low tight inventory owing to supply-demand mismatch. But one auto stock that could arguably be the most severely hit is used car e-retailer, Carvana (CVNA - Free Report) .

Pandemic-Era Winner Punished Brutally

Carvana’s run on the bourses over the past year has come as a rude shock for its investors. From being the top auto retail stock of 2020, Carvana has completely wiped out its COVID-pandemic fueled gains and is facing some seriously trying times lately. Shares of Carvana have plummeted more than 85% year to date and are currently trading at 90% off its 52-week high.  

The company had a blockbuster 2020 on the back of its compelling end-to-end online business model and zippy approach to selling cars. The robust demand for personal mobility amid coronavirus fears coupled with an early-mover advantage in digital sales gave the stock a boost. Carvana also benefited from rising demand and prices of used cars, as production halts tightened the availability of new vehicles. Low interest rates also aided the company. In 2020, the stock jumped more than 160% on the back of such tailwinds.

But those tailwinds that helped in the triple-digit growth are ebbing. Carvana has collapsed 85% so far this year amid a broader sell-off in Wall Street as investors stare at 40-year high inflation and a hawkish Fed. Investors are worried over a potential economic slowdown or even recession triggered by sky-high inflation, the Russia-Ukraine war, compounding supply chain snarls and the resurgence of COVID-19 infections and lockdowns in China. Of course, the company-specific issues are also weighing on Carvana.

But the important question here is whether this massive sell-off in Carvana shares represents a buying opportunity? Can the company turn around or is there more pain ahead?

Carvana Is Bleeding

No Annual Profit Yet: While the company’s revenue growth has been impressive, it has not yet turned an annual profit. In fact, its net loss has been widening every year since it went public in 2017. Net loss incurred in 2017, 2018, 2019 and 2020 was $164.3 million, $254.7 million, $364.6 million and $462.2 million, respectively. While Q2’21 marked the first positive net income quarter for the company, for the full-year 2021, the company again incurred a net loss of $287 million. Amid the firm’s persistently rising capital investments to expand the business, given that it is still in the early stage of development, Carvana wouldn’t be able to generate net annual profit this year as well.

Confidence-Shattering Q1 Report: The first quarter of 2022 was particularly a rough one for Carvana. On Apr 20, Carvana reported its quarterly results and missed the Zacks Consensus Estimate of earnings by 68%. It was Carvana's third miss in a row. The firm reported its first-ever quarter-over-quarter decrease in revenues. Net loss totaled $506 million (greater than the sum of its last five quarters loss’ combined) during the quarter. Gross profit per unit totaled $2,833 million, decreasing $833 million year over year. 

Carvana called the last reported quarter "challenging" and said it was not only due to events impacting the used vehicle industry as a whole, such as Omicron, used vehicle prices, interest rates but also due to events specific to Carvana, including reconditioning and logistics network disruptions. It should be noted that the stock has crashed around 67% since its dismal Q1 show.

What added to more uncertainty was the fact that the company refrained from providing specific numeric near-term guidance for the remainder of the year citing macro-economic headwinds. Discouragingly, the company pushed back the GPU expectation of over $4,000 by a few quarters. Also, its forecast of achieving EBITDA breakeven in the last three quarters of 2022 combined has been now pushed back amid broader industry challenges and macro-economic headwinds.

Weak Financials: Carvana’s stretched balance sheet is a major spoiler. As of Mar 31, 2021, Carvana’s long-term debt rose to $3,286 million from $3,208 million as of 2021-end. Its debt-to-capital ratio stands at 0.92 compared with the industry’s 0.17. Elevated leverage, both in absolute and relative terms, restricts the firm’s flexibility to tap growth opportunities. The firm’s debt is also quite high compared with cash and cash equivalents of $247 million. Its weak liquidity is reflected in the cash ratio of 0.22, lower than the industry’s 1.10.

Rating Downgrade: On Apr 25, Moody’s downgraded Carvana's CFR to Caa1 owing to negative FCF and continuous losses. The credit rating agency also doesn’t view the company’s decision to fund the ADESA U.S. operations acquisition partially with debt as very prudent given its already elevated leverage. As we know, Carvana heavily relies on debt offerings and equity sales to fund its growth. Per Forbes, Carvana has raised more than $8.8 billion so far this year via debt and equity offerings. Last month’s $3.3 billion bond sale—to fund the ADESA buyout as well for general corporate purposes— came with a hefty 10.25% annual interest payment.

Deepening Cash Burn: Carvana is a cash guzzler. It has been bearing the brunt of escalating SG&A expenses since its inception and the trend is likely to continue. SG&A costs amounted to $786.7 million, $1,126 million and $2,033 million in 2019, 2020 and 2021, respectively. In the last reported quarter, SG&A flared up 45.4% year over year. Amid high capex and other expenses, the firm hasn’t recorded positive free cash flow. In fact, between 2018 and 2021, Carvana’s negative FCF has deteriorated from $558 million to around $3.3 billion.

We Don’t See Much Respite

Investors seem to be disregarding Carvana’s ambitious growth targets and steering clear from the stock. With an unfavorable macro-environment including rising interest rates, inflation-weary customers and growing concerns of economic slowdown, we don’t think Carvana has bottomed out yet. Rising interest rates have made buying a car more expensive and will also weigh on Carvana’s loans securitization business. Increasing competition in the used car market is only making matters worse.

Investors’ appetite for Carvana’s debt pile also appears to be declining. They don’t seem too happy with the financing deal to fund the acquisition of ADESA's U.S. operations. They are concerned that the debt pile is huge and the interest rates on the borrowing would continue soaring.

Analysts and investors alike are skeptical if Carvana could meet its 2022 target of retailing more than 550,000 cars. As long as the management doesn’t deliver on its targets, it might be difficult for investors to restore faith in the stock. As it is, Carvana doesn’t have a good track record of cost-containment efforts. While its recent mass firing of 2,500 workers could be a right move toward this direction amid widening losses, the company would need to demonstrate tangible progress in the upcoming quarters if it wants to get into the good books of investors again. Till there is more clarity, we don’t see light at the end of the tunnel.

So, if you were thinking to take advantage of the recent price drop and bet on Carvana, it may be a bad idea. CVNA is a risky bet and may keep underperforming in the near term amid a slew of macro as well as company-specific headwinds. The Zacks Consensus Estimate for 2022 bottom line implies a year-over-year deterioration of 314%.  Notably, eight estimates were cut for the full year in the past 30 days. That has pushed the Zacks Consensus Estimate down to a loss of $6.75 from a loss of $4.10 just 30 days ago. CVNA currently carries a Zacks Rank #5 (Strong Sell) and has a VGM Score of F.

Park Your Money in These Auto Retailers

If you wish to invest in theauto retail space, here are two Zacks Rank #1 (Strong Buy) companies with strong fundamentals that can help you reap handsome profits.

AutoNation (AN - Free Report) : AutoNation is one of the world's largest automotive dealers.  Its first-quarter 2022 results marked the eighth consecutive quarter of record high numbers. A diversified product mix, strong footprint, a large dealer network and aggressive store expansion efforts are set to fuel the firm's profitability. The acquisition of Peacock Automotive Group and Priority 1 have buoyed AutoNation’s portfolio. Enhanced digital solutions have helped AutoNation to further boost profitability and market presence.

The Zacks Consensus Estimate for AN’s 2022 earnings and sales implies year-over-year growth of 23% and 6%, respectively. It has surpassed earnings estimates in the last four quarters, with an average surprise of 27.4%. AutoNation has a long-term EPS growth rate of 24.7% and a VGM Score of A.

Penske Automotive (PAG - Free Report) : Penske is riding high on strategic acquisitions. It has become the largest dealership group for Freightliner in North America with Warner Truck Centers buyout. The buyouts of Kansas City Freightliner, McCoy and Team Trucks Centers are boosting Penske’s top line. Notably, over the last 12 months, the company has completed acquisitions or opened new dealerships that would add $1.9 billion in annualized revenues. Expansion of digital capabilities, balance sheet strength and investor-friendly moves are other positives.

The Zacks Consensus Estimate for PAG’s 2022 sales and earnings implies year-over-year growth of 4% and 10%, respectively. It surpassed earnings estimates in the last four quarters, with an average surprise of 17.7%. Penske currently boasts a VGM Score of A.

You can see the complete list of today’s Zacks #1 Rank stocks here.

In-Depth Zacks Research for the Tickers Above

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Penske Automotive Group, Inc. (PAG) - free report >>

AutoNation, Inc. (AN) - free report >>

Carvana Co. (CVNA) - free report >>