How Carvana went from being a top pick on Wall Street to meme stock trading

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

The stock price has also risen this year, just in the wrong direction for investors. Within six months, Wall Street’s favorite used-car seller, Carvana, poised to take advantage of a robust market, has moved to trading as a volatile meme stock amid cost-cutting measures and layoffs.

The fall from favor for the Arizona-based used-car seller, including a nearly 90% drop in its share price since November, was the result of a mix of changing market conditions and self-inflicted wounds. Many traditional dealers continue to report record or near-record results, which shed new light on Carvana’s problems.

Carvana grew exponentially during the coronavirus pandemic, as shoppers switched to purchasing online rather than visiting a dealer, promising hassle-free sales and purchases of used vehicles at a customer’s home. But analysts are concerned about the company’s liquidity, mounting debt and growth, which this year is expected to be the slowest since it became a publicly traded company in 2017.

“The company itself admits it accelerated growth at exactly the wrong time to a consumer slowdown, creating a large capacity-demand mismatch, triggering a liquidity crisis,” Morgan Stanley’s Adam Jonas said earlier this month. in an investor note, downgrading its rating. company and lowers its price target from $360 to $105 per share.

The slowdown is partly due to high car prices, rising interest rates and fears of a recession. Carvana bought a record number of vehicles last year amid skyrocketing prices and soaring inflation, in preparation for unprecedented demand that has since slowed down.

Analysts say Carvana is far from out, but it may have peaked. There are concerns about the future used vehicle market and the short-term risks that outweigh the potential benefits.

“Deteriorating capital market conditions and deteriorating trends in the used auto industry have eroded our belief on the path for Carvana to secure the necessary capital to achieve sufficient scale and self-financing status,” Stifel’s Scott W. Devitt said in an investor note last week. †

Carvana stock is rated “hold” with a price target of $89.30 per share, according to analyst estimates compiled by FactSet.

Carvana’s stock stood at more than $300 a share before the company reported its third-quarter results on Nov. 4, when it missed Wall Street earnings estimates and internal operating issues were revealed.

Garcia, who also serves as chairman, told investors the company was unable to meet customer demand, preventing it from listing its entire fleet on its website for consumers to buy. He said it was a result of the company buying vehicles at a higher rate than it could handle.

“We weren’t prepared for it,” said Garcia, who co-founded the company in 2012 and has grown it to a nearly $13 billion company.

To support future vehicle sales and times to overhaul them, Carvana announced on Feb. 24 a definitive agreement to purchase the U.S. operations of Adesa – the second largest provider of wholesale vehicle auctions in the country – 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 auto retailer”. He ended his prepared comments with investors about fourth-quarter earnings that same day with, “the march continues.”

The deal was praised by investors, who sent the stock up 34% over the next two days to over $152 a share. It followed a steady decline due to fears of a recession and other macroeconomic trends impacting the used car market.

The gains from the deal were short-lived due to the macroeconomic environment, and the company significantly missed Wall Street’s expectations for the first quarter, leading to a sell-off of the company’s stock and a slew of cuts by analysts.

The company has been criticized for overspending on marketing, including a lackluster 30 second Super Bowl adand not prepare for a potential slowdown or setback in sales. Carvana says it was too well prepared for the first quarter after not being well prepared for demand last year.

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

The results plunged the stock the following week. Garcia described the problems as “transient” and something the company will learn from. He admitted that Carvana may have prioritized growth over profit as the company rolled back plans to achieve positive earnings before interest and taxes by “a few quarters.”

Shares took another hit in late April when the online used car dealer struggled to sell bonds and had to turn up to $1.6 billion to Apollo Global Management to bail out the deal to fund the Adesa deal.

Analysts view the deal to fund the purchase of Adesa as “unfavorable,” at a rate of 10.25%. Existing bonds already yielded more than 9%. Bloomberg News reported Apollo bailed out the deal after investors demanded a yield of about 11% on a proposed $2,275 billion junk bond and about 14% on a $1 billion preferred piece.

The adverse conditions will “inevitably slow the path” to positive free cash flow for the company through 2024, Wells Fargo analyst Zachary Fadem said. In a letter to investors on May 3, he downgraded the stock’s rating and lowered its price target from $150 to $65 a share.

RBC Capital Markets’ Joseph Spak expressed similar concerns about the deal, saying the integration could be “messy” over the next two years. He also downgraded the stock’s rating and lowered its price target.

“While the strategic rationale for Adesa makes sense, in our view the renovation and staffing of 56 facilities over the next few years will likely face a prolonged period of operational inefficiencies with as much as 18-24 months of ongoing bottom-line risks. he said in an investor note early last month.

Carvana shares hit a two-year low last week before soaring a whopping 51% the same day, along with “meme stocks” like GameStop and AMC.

Meme stocks refer to a select few stocks that suddenly become popular on the internet and lead to skyrocketing prices and unusually high trading volume.

For example, trading volume for Carvana on Thursday was over 41.7 million, compared to the 30-day average volume of about 9 million. Trading in Carvana shares was halted at least four times on Thursday.

Nearly 29% of Carvana stock available for trading is short selling, according to FactSet, one of the highest ratios in US markets.

Carvana tries to regain Wall Street’s favor. In an investor presentation released late Friday, the company defended the Adesa deal and updated its growth and cost-cutting plans, including reducing vehicle acquisition costs.

The company said it is refocusing its three key priorities: growing store units and revenue, increasing overall gross profit per unit and demonstrating operating leverage.

“We have made significant progress on the first two objectives,” the company said. However, it said it needed to do more, particularly with regard to profitability, free cash flow and selling, general and administrative expenses.

The company, in its presentation last week, reaffirmed reports that it has laid off 2,500 employees, or about 12% of its total workforce, and that Carvana’s executive team would not pay salaries for the remainder of the year to contribute to the severance package. fired employees.

Carvana’s recent troubles come as the country’s largest public dealer groups continue to report record or near-record profits amid low inventories and high prices.

The largest car dealer in the country, AutoNation reported record quarterly earnings per share of $5.78 for the first quarter last month. The company has aggressively switched to used vehicles amid a decline in new vehicle availability amid the coronavirus pandemic. Sales for its used car business increased 47% for the quarter, bringing total sales to nearly $6.8 billion.

Lithia Motors, which is in the midst of an aggressive growth plan to become the nation’s largest auto dealer, said its first-quarter profit more than doubled from a year earlier to $342.2 million. Average gross profit per unit for used vehicles — a figure closely watched by investors — rose 32% to $3,037. That’s comparable to Carvana at $2,833.

“Carvana seems to have gotten a lot of that halo of technology stocks that Tesla has also benefited from for a long time,” said Morningstar analyst David Whiston, who covers major publicly traded dealer groups but not Carvana. “I think maybe that was a little generous by the market.”

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