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Last March, I wrote that the likelihood of Carvana bankruptcy remained high (NYSE: CVNA). Since then, the stock has soared.As recently as February, I wrote that I expected stocks Make a big profit-related move in either direction, and it does. However, I also feel that the company may be surviving on borrowed time.As companies report earnings late februaryand management’s recent discussion of where GPU revenue will come from, let’s take a closer look at the name.
Company Profile
As a reminder, CVNA buys and sells used cars online. The company will deliver and/or pick up the vehicle to buyers, or they can go to one of CVNA’s car vending machines. The company has several refurbishment centers where it prepares vehicles before resale. CVNA also owns entities Car auction company ADESA.
Fourth quarter results
One of the first things to consider when it comes to CVNA is its balance sheet. As of 2023, the company had $6.3 billion in debt and $530 million in cash and equivalents. This compares to $5.9 billion in debt and $544 million in cash and equivalents in the third quarter, so its debt load has increased sequentially.
The company has significantly reduced its inventory over the past year, from $1.88 billion a year ago to $1.15 billion.
It is worth reminding that CVNA entered into a debt exchange agreement in September, reducing its total debt principal by $1.33 billion. The new note also has PIK interest (paid in kind) in the first year, and possibly PIK interest in the next two years on two of the three tranches, and then all three tranches will receive cash in the third year and beyond. Interest.
CVNA’s fourth-quarter operating cash flow was US$237 million, and its full-year operating cash flow was US$803 million. Free cash flow for the year was $716 million. However, this was due to inventory reductions, and when the company increased inventory in the fourth quarter, cash flow turned negative again. Also worth noting, if you dig into the numbers, you’ll see that there is $138 million in PIK interest that contributes to cash flow (since it’s non-cash), otherwise if it were paid in cash, OCF for the quarter would be -375 million Dollar.
Looking at CVNA’s operating performance in the fourth quarter, revenue fell by -14.6% to $2.42 billion. Meanwhile, retail unit sales fell -12.5% to 76,090 units.
Total gross profit per unit (GPU) was US$5,283, an increase of 138%, but lower than the US$5,952 in the third quarter. Adjusted GPU price was $5,730, up 155% but down from $6,396 in the third quarter. Gross profit increased 108% to US$402 million.
Retail GPUs jumped to $2,812 from $425 a year ago. Wholesale GPUs climbed from $230 to $526, while wholesale market GPUs rose from $46 to $158. Other GPUs (including financing, extended warranty, gap insurance, etc.) are $1,945, compared to $1,564 a year ago.
Adjusted EBITDA was $60 million, compared with -$291 million a year ago.
Going forward, the company expects retail unit sales to grow slightly from last year and adjusted EBITDA to exceed $100 million. The company said this equates to adjusted EBITDA of well over $1,200 per unit sold.
The company also said it expects to increase retail operations and adjust EBITDA by 2024.
When asked about operating leverage on the fourth-quarter conference call, CEO Ernie Garcia said:
“I think our view is that opportunities are everywhere, and I think a useful way to break them down is variable expenses and fixed expenses. I think fixed expenses, roughly how we manage them today, to keep them within bounds, we Expect it to leverage as we turn to growth. And then I think on the variable expense side, we still absolutely believe there’s going to be earnings. … I think there’s opportunity there as well from a unit gross margin perspective. I Think that’s true for basically every project. I would probably describe these as fundamental opportunities, meaning wherever we choose to price, such as rates or vehicles. We believe we can improve efficiencies in all of those areas. …It That could take the form of smarter understanding of how we buy cars, the data we use to estimate the value of those cars, some of the things we do when we receive the car to make sure we weed out the biggest losers. So I think there’s a lot more to it An exciting move.”
While CVNA’s stock price rose strongly from its quarterly results, I don’t think the results were particularly good given the debt position the company is in. After the quarter ended, the company’s debt leverage now stands at 17 times 2023 adjusted EBITDA ($339 million), a growing PIK. (Note that PIK interest is a non-cash charge but is included in the principal balance, thereby increasing the amount of debt.) A quarter of declining sales and negative operating cash flow suggests the company continues to struggle with growing and generating cash flow.
The company really needs to prove that it can achieve positive cash flow while increasing sales. Keep in mind that the PIK rate on its $4.2 billion of debt will be 12-14% in the first year, while the cash rate on all of its senior secured debt will be 9% in the third year. While the company’s unit gross profit improved, keep in mind that this differs from most companies because it includes wholesale revenue from its brick-and-mortar auction sites.
If it pays down its debt over the next two years, it would be back to $5.4 billion in long-term debt and nearly $500 million in interest payments by 2026. In this case, adjusted EBITDA of $100-150 million per quarter is really not worth mentioning. In my opinion, this helps a lot with its position, as most of it will be eaten up by interest payments. Meanwhile, that debt is now secured by all of CVNA’s assets, so it doesn’t really have much else to do.
Valuation
Based on 2024 EBITDA forecast of $483.5 million, CVNA trades at 30.6x. It trades at 22.6x based on 2025 EBITDA estimated at $652.3 million.
CVNA expects revenue to grow 3.5% this year and 15.5% next year.
The company currently has a leverage ratio of 17 times and net debt of $5.8 billion. When PIK’s interest is repaid, its $4.4 billion in senior secured loans will increase to $5.4 billion. So if it can hit its 2025 consensus without adding any additional debt, it will be leveraged over 10x and pay over $500 million in cash interest in 2026.
The company’s sales in 2023 will be approximately 313,000 vehicles. If sales grow at a modest 10% each year over the next two years, sales will reach nearly 380,000 vehicles. At that time, each vehicle would require $1,700 of Adjusted EBITDA. The company has said that adjusted EBITDA per vehicle will exceed $1,200 by the first quarter of 2024. However, reaching $1,700 could be a problem, as the company said at a conference earlier this month. Morgan Stanley Conference The majority of GPU revenue and SG&A reduction will come from costs of $25-50 per unit, with logistics being one of the largest areas.
However, there isn’t any money to really spend more on capex right now, and there doesn’t seem to be much upside for retail GPUs. Meanwhile, for example, the retail GPU price of the larger-volume CarMax (KMX) in the fourth quarter was about $2,300, and CVNA’s retail price was $2,812. There isn’t a lot of room to push retail GPUs any higher. The company has also cut sales and administrative expenses by $940 million in 2023, so it’s already quite lean.
So achieving $650 million in adjusted EBITDA without increasing sales, expenses, and debt seems like a tall order. A company with 10x leverage and little to no free cash flow could become a problem by 2026.
How CVNA Avoids Bankruptcy
To avoid bankruptcy, CVNA needs to continue to push its GPUs higher, lower SG&A, increase sales without increasing interest expenses too much, and generate stable cash flow after PIKing. The company has been able to do the first two, but must continue to push the envelope.
Increasing unit sales without increasing SG&A and adding more interest expense will be tricky, but if the company can pull it off, it will go a long way. Ad spend was down about -30% in the fourth quarter, so increasing sales without increasing advertising may also be a bit tricky. At the same time, it reduces a lot of inventory and lowers interest charges on vehicle floor plans in the process. Selling more vehicles without increasing inventory and financing that inventory will be difficult, but if it can do that, the company could find itself in pretty good shape.
in conclusion
The bottom line is, in my opinion, there was nothing in CVNA’s quarter or guidance that suggested the company could escape the massive debt load it faces. It’s doing some right things, like improving its GPU and making a small EBITDA profit, but it’s not showing that it can simultaneously grow revenue and generate free cash flow, which is what it needs to do to get out of its debt load. The company currently has limited means of cost cutting and GPU growth – it needs unit growth to match.
PIK’s high-interest debt, secured by all of its assets, is very onerous, and reporting results slightly above modest expectations doesn’t change what happens when it has to start paying cash interest on its debt.
CVNA will likely need around $1 billion in EBITDA annually to survive without taking on more debt. Considering that PIK will have interest on its secured debt of approximately $500 million per year upon completion and will also pay approximately $100 million in other interest payments per year, $1 billion of EBITDA should get you approximately $400 million in operating cash flow, This could at least reduce some debt.
However, since the company’s inventory is quite lean, managing growth and generating cash could be difficult. If it needs to finance new inventory (to actually increase sales), that may just result in more interest payments and less cash flow. CVNA has reduced inventory from $3.15 billion at the end of 2021 to $1.15 billion at the end of 2023.
That said, CVNA stock has historically been more volatile and tends to trade more on sentiment. The company has bought itself time, but any economic problems could have dire consequences for the company’s prospects.
I continue to rate the stock a “Sell” as I believe the likelihood of bankruptcy within a few years remains high. However, this takes some time to work.
