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

Carvana CEO Ernie Garcia III regularly told Wall Street that the company’s goal of becoming the world’s largest and most profitable used car retailer “continues to march.”

Its stock prices have risen this year as well, in the wrong direction for investors. Within six months, Carvana has moved away from Wall Street’s preferred used car retailer ready to capitalize on a strong market for transactions like a volatile meme stock between cost-cutting measures and pruning.

The fall from grace for Arizona-based used car retailers, including a nearly 90% fall in its stock price since November, is due to a mix of changing market conditions as well as self-inflicted wounds. Many traditional dealers continue to report record or near-record results, shedding more light on Carvana’s problems.

Carvana grew rapidly during the coronavirus epidemic, as buyers moved to online shopping instead of going to the dealership with the promise of hassle-free sale and purchase of used vehicles in the customer’s home. But analysts are concerned about the company’s liquidity, growing debt and growth, which is expected to be the slowest this year since becoming a public company in 2017.

“By the company’s own acknowledgment, it has rightly accelerated growth at the wrong time turned into a consumer recession that created a liquidity crisis with a large discrepancy between power and demand,” Morgan Stanley’s Adam Jonas said in an investor note earlier this month. The price target has been reduced to $ 105 per share.

High car prices, rising interest rates and the risk of a recession are among the reasons for the recession. Amid sky-high prices and rising inflation, Carvana bought a record number of vehicles last year, in preparation for unprecedented demand that has since slowed.

Analysts say Carvana is far away, but it may have reached the top. As the used car market moves forward, there are concerns about its near-term risks rather than potential rewards.

Scott W. Davitt of Steffel said in an investor note last week, “The deteriorating state of the capital market and the growing trend in the used vehicle industry has undermined our conviction on the way to Carvana to secure the capital needed to realize adequate scale and self-financing.” .

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

Carvana’s stock was up more than $ 300 per share before reporting the company’s third-quarter results on November 4, when it missed Wall Street earnings expectations and revealed internal operational problems.

Garcia, who also serves as chairman, told investors that the company could not meet customer demand, which is why it does not provide its entire vehicle on its website for customers to buy. He said it was the result of buying cars at a higher rate than the process.

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

Future throughput of vehicle purchases and to recover them, Carvana announced on February 24 that it had finalized a deal to buy Adesa’s U.S. operations – the second largest supplier of wholesale car auctions in the country – KAR 2.2 billion from KAR Global.

Garcia said at the time that the deal “confirmed” Carvana’s plans to become “the largest and most profitable automotive retailer”. The same day concludes his prepared remarks with investors for fourth-quarter earnings, “March continues.”

The deal was welcomed by investors, who sent the stock up 34% over the next two days to more than 2 152 a share. It has followed a steady decline due to recession fears and other macroeconomic trends affecting the used car market.

Profits from the deal were short-lived due to the macroeconomic environment, and the company significantly exceeded Wall Street expectations for the first quarter, the company’s stock began to sell, and many downgraded by analysts.

The company was criticized for spending too much on marketing, including a weak 30-second Super Bowl ad and not preparing for a potential slowdown or recession in sales. Carvana argues that it was extra prepared for the first quarter after less preparation for last year’s demand.

“We made it for more than show,” Garcia said during an earnings call on April 20.

Results Tanked next week. Garcia described the problems as “temporary” and something the company would learn from. He acknowledges that Carvana may be prioritizing growth over profit, as the company has pushed back its plan to earn positive earnings before interest and taxes by “a few quarters”.

The stock hit again in late April, when an online car dealer struggled to sell bonds and was forced to go to Apollo Global Management for $ 1.6 billion to defend its Adesa deal financing deal.

Analysts view the financing agreement to buy Adesa at 10.25% as “unfavorable”. Its existing bonds are already yielding over 9%. According to Bloomberg News, investors saved the Apollo deal after claiming about 11% yield on the proposed 2 2.275 billion junk bond and about 14% yield on the অংশ 1 billion preferred portion.

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

Joseph Spock of RBC Capital Markets expressed similar concerns about the deal, saying the consolidation could be “messy” in the next two-plus years. He downgraded the stock and lowered its price target.

“While the strategic rationale for Adesa is understandable, in our view, restoring 56 facilities and hiring staff over the next few years could lead to long-term operating inefficiency and 18-24 months of ongoing low-line risk,” he said. An investor said in a note earlier this month.

Shares of Carvana hit a two-year low last week before rising 51% on the same day, including “meme stocks” like Gamestop and AMC.

Meme stock refers to a select few stocks that suddenly gain popularity on the Internet and carry sky-high prices and unusually high transaction volume.

For example, Carvana’s trading volume on Thursday was over 41.7 million, compared to its 30-day average volume of about 9 million. Shares of Carvana were closed at least four times on Thursday.

According to FactSet, about 29% less shares of Carvana available for trading are sold in the U.S. market than in the highest proportion.

Carvana is trying to return to the good graces of Wall Street. In an investor presentation released late Friday, the company defended the Adesa deal and updated its plans to increase and reduce costs, including reducing the cost of acquiring its vehicles.

The company said it was re-focusing on its three main priorities: growing retail units and revenue, increasing gross profit per unit and showing operating leverage.

“We’ve made significant progress on the first two goals,” the company said. However, it says it needs to do more, especially in terms of profitability, free cash flow and sales, general and administrative costs.

The company, in a presentation, reaffirmed reports last week that it had cut 2,500 employees, or about 12% of its total workforce, and that the Carvana executive would cut pay for the rest of the year to contribute to severance pay for retired employees.

Carvana’s recent problems come as the country’s largest public dealer groups continue to report record or near-record gains in low inventory and high prices.

The country’s largest auto retailer, Autonation, earned $ 5.78 per share in a record first quarter last month. The company has moved to aggressively used vehicles amid a decline in the availability of new vehicles during the coronavirus epidemic. Its used-car business revenue grew 47% in the quarter, pushing its total revenue to about $ 6.8 billion.

Lithia Motors, which is in the midst of an aggressive growth plan to become the country’s largest vehicle retailer, said its profits more than doubled in the first quarter from a year earlier to $ 342.2 million. Average profit per unit for used vehicles – a statistic closely monitored by investors – rose 32% to $ 3,037. That compares to Carvana at $ 2,833.

“Carvana seems to have gotten a lot of the tech stock hello that Tesla has benefited from in the long run,” said David Houston, a Morningstar analyst who covers major public trade dealership groups, not Carvana. “I think it was a bit generous by the market.”

– CNBC’s Michael Bloom And Hannah Miao Contribute to this report.