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Last March, I wrote that bankruptcy was still a very real possibility for Carvana (NYSE:CVNA). The stock has skyrocketed since then. More recently in February, I wrote that I expected the stock to make a big move in association with earnings in either direction, which it did. However, I also felt that the company could be living on borrowed time. With the company reporting earnings in late February, and management recently discussing where GPU gains would 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 vehicles from buyers or they can go to one of CVNA’s car vending machines. The company owns a number of reconditioning centers that it uses to prep vehicles before re-selling. CVNA also owns physical car auction business ADESA.
Q4 Results
One of the first things to look at with CVNA is its balance sheet. The company ended 2023 with $6.3 billion in debt and $530 million in cash and equivalents. That compared to $5.9 billion in debt and $544 million in cash and equivalents in Q3, so its debt load increased sequentially.
The company has significantly reduced its inventory over the past year, taking it from $1.88 billion a year ago to $1.15 billion.
As a reminder, CVNA entered into a debt exchange agreement in September, that lowered its total debt principal by $1.33 billion. The new notes also had PIK interest (pay in kind) in the first year and potentially the next two for two of the three tranches, and then all three will have cash interest in year three and thereafter.
CVNA generated -$237 million in operating cash flow in Q4 and $803 million for the year. FCF was $716 million for the year. However, this was from inventory reduction, and when the company added inventory in Q4, its cash flow once again turned negative. It's also worth noting that if you dig into the numbers, there was $138 million in PIK interest that helped cash flow (since it's non-cash), otherwise OCF would have been -$375 million in the quarter if it was a cash payment.
Looking at CVNA’s Q4 operational results, revenue declined -14.6% to $2.42 billion. Retail units sold, meanwhile, fell -12.5% to 76,090 units.
Total gross profit per unit (GPU) was $5,283, an increase of 138%, but was down from $5,952 in Q3. Adjusted GPU was $5,730, up 155%, but down from $6,396 in Q3. Gross profit rose 108% to $402 million.
Retail GPU jumped from $425 a year ago to $2,812. Wholesale GPU climbed to $526 from $230, while wholesale market GPU rose from $46 to $158. Other GPU - which includes financing, extended warranties, gap insurance, etc. – was $1,945 versus $1,564 a year ago.
Adjusted EBITDA came in at $60 million versus -$291 million a year ago.
Looking ahead, the company is looking for retail units sold to be up slightly year over year and for adjusted EBITDA of over $100 million. It said that equates to adjusted EBITDA of well over $1,200 per unit sold.
The company also said for 2024 it expects to grow retail units and adjusted EBITDA.
Asked about operating leverage on its Q4 call, CEO Ernie Garcia said:
“I think our view is there's opportunity everywhere, I think a useful way to break it down is kind of variable expenses and fixed expenses. I think fixed expenses, roughly the way we're managing that today is holding that in the range, and we expect that to lever as we turn to growth. And then I think in variable expenses, we still absolutely believe that there are gains to be had. ... I think from a gross profit per unit perspective, there's also opportunity there. And I think that's true in basically every line item. I would kind of probably characterize those as fundamental opportunities, meaning regardless of where we choose to price things like rates or the vehicle. We believe we can be more efficient in all those areas. ... It can take the form of getting smarter about how we're buying cars, the data that we're in taking to evaluate the value of those cars, a number of things that we're doing at the point of receipt of the cars to make sure that we're cutting out the biggest losers. So I think there's a number of initiatives there as well that are pretty exciting.”
While CVNA's stock rallied strongly off its quarterly results, the results were not particularly good in my view given the debt situation the company finds itself in. Following the quarter, the company is now leveraged 17x its 2023 adjusted EBITDA ($339 million) with its debt PIK and growing larger. (Note that PIK interest is a non-cash expense, but it accrues to the principal balance, increasing the debt amount.) A quarter with declining sales and negative operating cash flow shows that the company continues to struggle both growing and generating cash flow.
The company really needs to show that it can grow sales and be cash flow positive at the same time. Remember, $4.2 billion of its debt is PIKing at between a 12-14% rate in year one, and all of its senior secured debt will have a 9% cash interest rate in year three. While the company has shown progress with its gross profit per unit, remember this is not apples to apples with most firms, as it includes wholesale revenue from its physical auction site.
If it PIKs its debt the next two years, it will be back to having $5.4 billion in long-term debt and nearly $500 million in interest expense in 2026. In that scenario, $100-150 million in adjusted EBITDA a quarter really doesn’t help its situation much in my view, as most of it will be eaten up by interest expenses. Meanwhile, this debt is now secured by all of CVNA’s assets, so it doesn’t really have many other moves to make.
Valuation
Based on 2024 EBITDA projections of $483.5 million, CVNA trades at a 30.6x multiple. Based on 2025 EBITDA estimates of $652.3 million it trades at 22.6x multiple.
CVNA is expected to see revenue rise 3.5% this year, before growing 15.5% next year.
The company is currently leveraged 17x with $5.8 billion in net debt. Its $4.4 billion in senior secured loan will rise to $5.4 billion when it's finished with its PIK interest. So if it can achieve the 2025 consensus without adding any additional debt, it would be over 10x leveraged, and have over $500 million in cash interest payments in 2026.
The company sold about 313,000 units in 2023. If modestly grows units 10% each of the next two years, that would get it to near 380,000 units. At that point, it would need $1,700 in adjusted EBITDA per vehicle. The company has talked about being over $1,200 in adjusted EBITDA per vehicle in Q1 of 2024. Getting to $1,700 could be an issue, though, as the company indicated earlier this month at a Morgan Stanley conference that much of its GPU gains and SG&A reductions would come from things that were $25-50 per unit, with logistics being one of the biggest areas.
However, there isn't any money to really spend more on Capex at this time, and retail GPU doesn't appear to have much room to move much higher. Meanwhile, for example, CarMax (KMX), which is larger by number of vehicles sold, is at a retail GPU of around $2,300 and CVNA is at $2,812 in Q4. There just isn't much more room to push the retail GPU much higher. The company also already cut SG&A in 2023 by $940 million, so it is already pretty lean.
Thus, getting to $650 million in adjusted EBITDA without ramping up sales and expenses and debt seems like a difficult task. And a 10x leverage company with little free cash flow in 2026 could be an issue.
How CVNA Avoids Bankruptcy
To avoid the fate of bankruptcy, CVNA will need to continue to push up its GPU, lower SG&A, increase unit sales without adding much interest expense, and generate solid cash flow after PIKing. The company has been able to do the first two, but must continue to push the limits even more.
Increasing unit sales without increasing SG&A and adding more interest expense will be tricky, but if the company can pull this off, this would go a long way. Ad spend was down about -30% in Q4, so ramping up sales without ramping up advertising can also be a bit tricky. Meanwhile, it reduced a lot of inventory, and in the process lowered the interest expense of its vehicle floor plan. Selling a lot more vehicles without adding more inventory and inventory financing will be difficult, but if it can do this, the company could find itself in pretty good shape.
Conclusion
At the end of the day, there was nothing in CVNA’s quarter or guidance to suggest the company can escape the huge debt burden it finds itself under in my view. It's doing some things rights, like improving GPU and turning a small EBITDA profit, but it hasn't shown it can grow revenue and generate free cash flow at the same time, which it will need to do to get out from under its debt burden. There is only so many cost cuts and ways for the company to growth its GPU from here - it needs unit growth to go with that.
High interest PIK debt secured by all its assets is very onerous, and reporting results slightly above muted expectations does not alter what happens when it must start paying cash interest on its debt.
CVNA likely needs to get to around $1 billion a year EBITDA without taking on more debt to survive. Given that interest just on its secured debt will be around $500 million a year once the PIK is complete and it is paying about another $100 million a year in other interest, $1 billion in EBITDA should get you to around $400 million in operating cash flow, which could then put at least some dent into that debt.
However, with the company running pretty lean inventories, managing to grow and generate cash could prove difficult. If it needs to finance new inventory, which it would need to really grow sales, that would potentially only lead to more interest expense 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's stock has a history of being volatile and often trades more on emotion. The company has bought itself time, but any economic hiccup could be dire for the company's prospects.
I continue to rate the stock a “Sell,” as I think the probability of bankruptcy in a few years remains high. However, it is going to take some time for this to play out.
