A better-than-expected second quarter and a debt restructuring deal for Carvana does not mean smooth roads ahead, analysts said.
Online used-vehicle retailer Carvana announced better-than-expected second- quarter results and a new debt restructuring deal on Wednesday, July 19.
Analysts lauded the improved results and the flexibility afforded by the deal. But those same analysts and others noted that the debt relief is temporary and the company still reported a significant, if much narrower, loss. Carvana needs to demonstrate its business model can consistently deliver results, they said.
The debt restructuring could buy Carvana some temporary relief. However, the high payment-in-kind coupons for the first two years “will likely put the company back in nearly the same position it was previously absent a meaningful improvement in the business or a redemption of some or all of the new notes,” J.P. Morgan analysts wrote.
Present and future
Experts weigh in on Carvana’s second-quarter results and debt restructuring deal, and what this means for the company in the days and months ahead.
“All-in, the debt swap and equity offering are likely enough to carry Carvana to the other side of a tough used-car market while eliminating most insolvency concerns.” — Sharon Zackfia, William Blair
“Carvana has proven it can drop expenses significantly by dramatically shrinking the business.” — Douglas Arthur, Huber Research Partners
“A deal was suspected when [Carvana] moved up [its second-quarter earnings report]; today’s ~$1.2 billion debt reduction and [gross profit per unit]/EBITDA beat go a long way toward cleaning up the [Carvana] narrative. We’d like to get more constructive, but questions remain and $5 billion-plus of debt still holds us back.” — Wells Fargo
“We view the offer as tantamount to default because we believe lenders will receive less than originally promised. … In our view, Carvana is pursuing this transaction because its capital structure is unsustainable and the company has limited options to reduce its debt burden and improve its cash flow organically.” — S&P Global Mobility
“On balance, we view the debt exchange and concurrent equity raise as a meaningful positive for Carvana in the near term, as it extends the company’s debt maturities, notably clearing out the front end, while meaningfully reducing its cash interest costs for the first two years.” — J.P. Morgan
“Carvana’s brand recognition, in our view, is a competitive advantage and its ability to leverage the latest technology positions the company as a premium name.” — Michael Ward, Benchmark Co.
S&P Global Mobility took a harsher stance, calling the proposed restructuring “distressed and tantamount to default.”
While the deal would extend Carvana’s maturities and offer interest savings, S&P Global Mobility said that lenders will receive less than originally promised.
“The principal amount of the new securities offered is less than the original par amount, the new maturities extend beyond the original dates, and the timing of payments will be slower by adding a [payment-in-kind] feature,” company analysts wrote in a statement on Thursday, July 20. “In addition, debtholders are essentially being primed by the senior position of the new notes. In our view, Carvana is pursuing this transaction because its capital structure is unsustainable and the company has limited options to reduce its debt burden and improve its cash flow organically.”
Stephens Inc. analyst Daniel Imbro said Carvana’s restructuring decision reflects the challenging used-vehicle market and the company’s hopes for the future. The white-hot used-car market of the past two years amid a slowdown in new-car production has cooled in recent months. Wholesale used-vehicle prices fell in April, May and June — the last month registering a 4.2 percent drop.
Public dealership group Sonic Automotive last month scaled back its EchoPark footprint in part because of lower used-vehicle availability.
Jonathan Smoke, Cox Automotive chief economist, has taken a glass-half-full view of the used-vehicle market. He recently said the worst is occurring now and that things will improve in the second half of 2023.
Imbro, however, said he expects the used-car market to be challenging well into 2024, with affordability remaining a key issue. Whether Carvana can grow as the market improves is unknown.
Garcia: “Darling” status no more
“We would love for car prices to drop,” Carvana CEO Ernie Garcia told Bloomberg TV on Thursday. “It would be great for us and great for our customers. We look forward to that as it looks like it may be approaching. Over time, our best expectation is probably that car prices come down.”
Carvana struggled in 2022. Plagued by a weakening used-vehicle market, its stock plummeted 98 percent, erasing almost $37 billion of market capitalization.
Garcia said in November that the company was no longer the investor “darling” it had been during the pandemic.
“We’re now back to a place where we’ve spent most of our lives, and I think, honestly, it’s a comfortable place to be,” Garcia said. “I think it’s what we’re used to, and it’s sort of easier to stay focused and build. It’s easier to get motivated when people don’t believe in you than when people do.”
Mounting financial losses, a plunging stock price, nervous creditors and regulatory roadblocks in several states had the online used-car giant on the ropes as it entered 2023, facing doubts about its ability to survive without major restructuring amid a used-vehicle market in decline.
After soaring to a market valuation of up to $60 billion in 2021, the retailer had charted an aggressive growth strategy for 2022, expecting strong used-car demand to carry over from the previous two years. When that didn’t happen, Carvana became entrenched in cost-cutting mode, posting an annual loss of $1.6 billion in 2022. Meanwhile, its large debt load loomed and its business model floundered.
A reduction of growth initiatives and inventory size in early 2023 saw the company sell fewer cars but ultimately perform better, with improved total per-vehicle profit and a slimmer net loss.
That trend continued in the second quarter. Carvana sold 76,530 vehicles — even fewer than in the first quarter — but gross profits per vehicle improved again, climbing to $6,520, nearly double what it was in the second quarter last year.
Carvana is facing tough competition, not only from traditional car dealerships but from other online companies such as Cars.com, TrueCar and CarMax.
On the bright side, Michael Ward, an analyst for Benchmark Co., wrote that Carvana has maintained a competitive advantage in brand recognition.
William Blair analyst Sharon Zackfia said that in the long term, the company’s business model has merit.
“We continue to believe value exists in Carvana’s customer-friendly, digitally enabled model, as evidenced by continued market share gains notwithstanding the difficult industry backdrop,” she wrote. On the other hand, Carvana’s historic failure to make a profit and the challenging macroeconomic environment continue to be risks, she said.
Carvana’s much lower net loss this quarter and its higher adjusted earnings before interest, taxes, depreciation and amortization benefited from about $70 million of nonrecurring items. Analysts said they want to see if its relative success this quarter is repeatable.
“Improved bottom line performance is very encouraging and the debt exchange removes some near-term cash flow pressure,” Huber Research Partners analyst Douglas Arthur said. “All that said, despite help from several unusual items in Q2, Carvana still lost over $100 [million] on the bottom line. Too early to claim victory here.”
The company said second-quarter adjusted earnings before taxes and other expenses swung to $155 million from a loss of $216 million in the same quarter last year. Carvana executives praised improved gross profit per vehicle and decreased costs, but analysts said the retailer needs to prove those successes can last.
“We would like to see evidence that these are repeatable and the company can return to growth while keeping expenses lower,” Imbro said.
Despite positive week, Carvana still on thin ice, analysts say
Carvana future still uncertain despite recent developments
A better-than-expected second quarter and a debt restructuring deal for Carvana does not mean smooth roads ahead, analysts said.
A better-than-expected second quarter and a debt restructuring deal for Carvana does not mean smooth roads ahead for the online used-vehicle retailer, analysts said.
