Debt market doubts Carvana’s survival – Interest charges could jump

Joe Raedle

Online used car dealership Carvana (New York stock market :CVNA) has lost half its value in the past five days after its third-quarter earnings showed signs of slowing sales and GPU weakness, among other things, as Morgan Stanley also hit stocks with a target price of $0.10. by Carvana The woes continued to deepen as the used-car vending machine operator faces tough macroeconomic headwinds and an inability to effectively manage costs. Bonds have fallen significantly, signaling what could be the final nail in the coffin of heavily indebted Carvana as interest charges rise.

Macro headwinds galore

Carvana is succumbing to a whirlwind of headwinds in the used car market as used vehicle prices fall and rates rise.

AutoNation Automotive Retailer (A) warned that “used car prices are slowing as rising interest rates dampen demand from more price-sensitive shoppers” as it reported weaker-than-expected third-quarter results. CEO Mike Manley said the retailer “was starting to see prices used cars fade with faster depreciation”. CarMax (KMX) also reported “affordability challenges” in the used-car market.

Manheim Used Vehicle Index October 2022

Manheim Used Vehicle Index (Cox Auto)

yoused vehicle prices are “fall off a cliff“, down 10.6% year-on-year for October, marking a 2.2% decrease year-on-month from September, according to the Manheim Used Vehicle Index. As shown below, all the various market categories recorded declines of more than 5% in October, with SUVs, midsize cars and luxury cars registering double-digit declines.

Manheim Used Vehicle Index, October, Year-on-Year Decline by Vehicle Category

Manheim Used Vehicle Index (Cox Auto)

The index surged throughout 2021 as tight supply resulting from the chip shortage caused prices to rise rapidly. However, interest rate hikes leading to higher auto loan rates, although easing supply chain issues have helped used vehicle inventory.

Auto loan rates have risen dramatically, reflecting affordability issues highlighted by CarMax. Until October, the “weighted average auto loan rate all loan types rose 2.8 percentage points to 10.6%. ” beginning of October increased by 2pp to 11%. Future rate hikes could continue to drive up lending rates, further straining the affordability of millions of potential buyers.

The market seriously doubts the survival of Carvana

In addition to stocks plummeting after earnings, debt fell rapidly as trust in the used car dealership is rapidly eroding. All Carvana bonds lost value as the recent earnings report highlighted GPU weakness, continued losses and high interest charges from these high yield bonds.

Take the one from Carvana senior unsecured notes 2025 deadline:

Carvana 2025 senior unsecured notes due 2025.

FINRA

The rating traded between 73.5 and 87.5 from March to the end of September, signaling that the market still firmly believed that Carvana would continue its disruptive journey, headwinds would subside and cash flow and Positive EBITDA would come back and enable the $500 million note. to be reimbursed in full.

After third-quarter earnings, the rating fell dramatically from $65.25 to $44.5, a quick and sharp 31% drop almost mirroring the stock’s 39% decline after earnings. The rest of Carvana’s rating also went down:

  • 2027 (600mm): $53 to $36.75
  • 2028 (600mm): $44.5 to $34.45
  • 2029 (750mm): $44.75 to $32
  • 2030 (3275mm): $61 to $46.25

In total, Carvana has a total debt of $5.725 billion, with all of that debt trading at less than half face value, with 2029 notes trading at less than a third of face value. Trading at such challenging levels suggests that the debt market has lost substantial confidence in Carvana’s ability to continue operations beyond 2025 if it cannot raise a substantial amount of cash or quickly reverse course for generate positive cash flow amid growing headwinds.

Revenue corroborates lack of trust

Carvana reported a 3% drop in revenue while retail units sold fell 8%. However, net numbers fell as gross profit fell 31% as GPU fell significantly, while net margin widened to (15.0%).

Carvana reported that “the rapidly rising interest rate environment is creating a headwind for conversion and total GPU” – no surprise here. Additionally, Carvana said that “lower conversion and total GPU reduces the number of profitable sales, all else being equal, leading us to further reduce sales volume.” Sales volume did not drop dramatically, with central US markets showing slight growth.

Carvana is also far from reaching its EBITDA targets:

Carvana's long-term financial objectives

carvana

Carvana barely delivered a positive EBITDA margin in FY21 when revenue growth rates were >100% YoY each quarter. Gross margin has fallen back below its long-term target range, but Carvana still significantly exceeds general and administrative expenses; it only managed to reduce general and administrative expenses by $90 million in the third quarter. With SG&A at almost 20% of revenue, the highest since FY18, Carvana is still very far from hitting its targeted single-digit range.

On a unit basis, Carvana’s consolidated general and administrative expenses of $6,396 totaled approximately 183% of the GPU of $3,500 per unit. Compensation/benefits and advertising alone accounted for $3,315 in unit costs, or 94.7% of the GPU. Carvana should drastically reduce both of these cost categories, but it’s next to impossible – advertising is absolutely necessary to attract customers to the site and drive purchases, while compensation cannot be reduced by 30% easily.

Carvana posted a GPU of $4,671 in Q3 2021, again during a boom in the used vehicle market when revenue growth topped 125%. Even if Carvana manages to grow the current $3,500 GPU by 20% to $4,200 in two to three quarters, while facing higher refurbishment costs due to parts shortages and potential cost impacts (in addition to lower used vehicle prices), SG&A would need to be cut by more than 30% to help put Carvana on the path to profitability.

Interest expense to skip 220%

Although not highlighted in the earnings report, Carvana’s net interest expense on its debt is increasing – since November 1, the company has just started paying a semi-annual coupon on its 10.125 notes. % of $3.275 billion following its acquisition of ADESA.

Interest expense on these notes is approximately $336 million annually. This will now be in addition to Carvana’s $153 million in interest expense, bringing Carvana’s total interest expense to $489 million in FY23.

Carvana’s cash, cash equivalents and restricted cash totaled $477 million at the end of the third quarter, which is not even enough to repay its debt with a little reserve. Adding short-term investments to the mix brings cash to $827 million, adding an ounce of leverage to Carvana’s ability to service its debt. As stocks remain depressed, Carvana will likely need to dip into existing credit facilities to pay down debt, issue more debt, or significantly dilute its stock to raise funds so it can manage its debt load. Servicing debt by issuing debt is a death spiral, as new debt will come with higher rates and higher coupon payments; Given these factors, it is clear why Carvana’s ratings quickly lost value to trade in distress.

Outlook

Carvana’s outlook remains negative following its latest earnings report, which highlighted macroeconomic headwinds negatively affecting the GPU as SG&A has yet to pull back. Carvana will likely struggle to achieve positive EBITDA, as its major expenses are concentrated in the core areas of compensation, benefits and advertising, while a downward trend in used vehicle prices and Higher auto loan rates loom on the results ahead in the fourth quarter. Carvana notes plunged into distress after earnings as the company’s survival is now in serious doubt, made worse by net interest charges which jumped 220% next year to just under of $500 million as coupon payments on the $3.275 billion notes to fund the ADESA acquisition begin.

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