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Will Carvana Stock Continue to Defy Gravity?

Barchart - Tue Aug 1, 10:39AM CDT

After a dismal performance in 2022, Carvana (CVNA) stock has sped past even its best-performing rivals on a year-to-date basis. CVNA is up by a whopping 904% in 2023, markedly outpacing the performance of its peers like Vroom (VRM) (+134% YTD), CarGurus (CARG) (+58% YTD), and CarMax (KMX)  (+36% YTD).

So, should you be a buyer of Carvana at these prices? Let's take a look at whether the surge in stock price is justified by the fundamentals and whether it's valued appropriately relative to its competition. 

About Carvana

Founded in 2012 by Ryan Keeton and Ben Huston, Carvana is an Arizona-based online used car retailer with a presence in over 300 cities across the U.S. through its network of car vending machines and inspection centers. In 2021, Carvana became one of the youngest companies to make it to the Fortune 500 list. 

Carvana has gained considerable brand recognition over the years. According to a July 2022 Statista survey, Carvana rates well with its customer base in terms of popularity, awareness, loyalty, and buzz.

At its current price, the company commands a market cap of $8.7 billion. 

Reasons for the Rally

After the stock collapsed to all-time lows in December 2022 on bankruptcy concerns, a more optimistic financial outlook for Carvana has been a key driver behind the huge rally in 2023.

Notably, net losses for the company narrowed considerably from about $1.4 billion in the December 2022 quarter to $105 million in the June 2023 quarter - a bottom-line improvement of nearly 93% in the past six months. Meanwhile, gross profit per retail unit almost tripled to $6,520 in the second quarter compared to from $2,219 in the final three months of 2022.

In addition to beating analysts' second-quarter profit and revenue results, Carvana also announced a debt swap that should reduce its debt by $1.2 billion. This is expected to result in a cash interest expense reduction of more than $430 million annually for the next two years, which should support the retailer's plans to deliver profitability.

On a macro basis, optimistic forecasts for the online used car market are also a positive for Carvana stock. According to a report by Mordor Intelligence, the U.S. online used car market is expected to reach $302.47 billion by 2027, up from $195.84 billion in 2021. Carvana remains the second-largest player in the space, with a market share of 19% - comfortably above Vroom at 12%, although half that of market leader CarMax at 38%. 

Concerns Remain

However, critical concerns remain about Carvana, which could be a risk to the share price performance in the future.

For example, deliveries missed expectations in the second quarter, and the miss was reflected in softer sales numbers. In the April-June period, retail vehicle unit sales fell 35% to 76,530 units, while Carvana reported net sales of $2.97 billion, down 23.6% from the prior year. 

And this is not a one-time phenomenon, either. Sales have consistently declined on a sequential basis from $3.9 billion in the second quarter of 2022, and the same is true of retail vehicle unit sales, which have decreased steadily each quarter from 117,654 a year ago. 

The declining revenue and unit sales over the past fiscal year suggest lesser demand for Carvana's products relative to FY21, when revenues jumped 129%.

Legal challenges also continue to plague the company, with Carvana facing lawsuits from customers in a slew of states over titles and registration issues.

Valuations Stable Compared to Peers 

Carvana's valuation appears relatively fair when compared to its peers.

The stock is currently trading at a forward enterprise value/sales (ev/sales) ratio of 1.05. This is comparable to Vroom's ev/sales of 0.89, and CarMax's 1.18.

Elsewhere, the price-to-sales (p/s) ratio for Carvana of 0.61 is within range of CarMax's 0.44, but higher than Vroom's at 0.15.

Analyst Estimates

Analysts seem convinced about Carvana's ability to achieve earnings growth. For the current quarter, analysts are looking for a 64.04% increase in earnings, and a 51.04% rise for FY 2023 overall.

That said, most analysts have a “Hold" rating on the stock, with a mean target price of $39.18 - indicating a downside potential of about 15% from current levels. Out of 21 analysts covering the stock, one has a “Strong Buy” rating, 15 have a “Hold” rating, and 5 have a “Strong Sell” rating.

Final Takeaway

The runaway price action in Carvana shares appears impressive. However, I believe the rally has been overdone, even taking into account the company's narrowing losses, stable valuation, and strong market share in a growing market.

This is simply because Carvana's underlying demand appears weak. The company has reported declines in revenue and units sold persistently over recent quarters. Plus, the company's substantial debt load of $5.6 billion (even after the $1.2 billion debt reduction measure) remains a concern.

Moreover, website visits are down roughly 40% year-over-year, and the number of vehicles listed online is down almost 50%, too.

All things considered, I would suggest investors who have been a part of this rally should book profits in Carvana, and deploy their capital elsewhere. Meanwhile, investors looking to add new positions in Carvana stock should avoid doing so at these levels.

On the date of publication, Pathikrit Bose did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.

Provided Content: Content provided by Barchart. The Globe and Mail was not involved, and material was not reviewed prior to publication.