Debt-laden Carvana narrows losses

Carvana Co. made progress in cutting its expenses and driving up per-vehicle profit in the first quarter. Now the debt-laden retailer must work to sustain its momentum and preserve liquidity.

The online used-vehicle giant in recent quarters has pumped the brakes on its growth-at-all-costs approach, something it found necessary as inflation and rising interest rates converged to disrupt consumers' used-vehicle buying habits. Carvana — which also faces steep interest payments each quarter — says it has prioritized initiatives aimed at improving its per-vehicle economics.

That shift in strategy was clear in Carvana's report last week: It sold just over 79,000 vehicles in the quarter ended March 31, down 25 percent from a year earlier, as it reduced its net loss by more than 40 percent.

After a robust 2021, Carvana expected another similar year, but it ended up "being pretty dramatically out of balance with where sales actually were" in 2022, CEO Ernie Garcia said during the company's earnings call last week.

The retailer's first-quarter performance beat several analysts' expectations. It recorded a $286 million net loss, slimmer than the $506 million loss in the year-earlier period. Its share price, which fell 98 percent last year, jumped by double-digits to $8.96 on Friday, May 5.

For now, Carvana, of Tempe., Ariz., appears on track to "avoid the doomsday scenario that so many have been predicting," analysts for Piper Sandler wrote in a research note published last week. They noted that the company's aggressive cost cutting and tighter inventory management in the first quarter boosted its cash flow and staved off bankruptcy concerns.

Carvana said it captured total per-vehicle profit of $4,303, up 52 percent from the year-earlier period and ahead of analysts' expectations.

"We've already got our plans for the next nine to 12 months to keep the pedal down and keep making a lot of progress on unit economics," Garcia said. "We plan to do that at somewhat similar volumes to where we are today."

Once it achieves that, Carvana will turn its attention back to growth and capturing more market share, Garcia said.

The company did note in a letter to shareholders that some of the factors that led to the improved total per-vehicle profit were one-time or transitory. For instance, Carvana's retail profit per vehicle — $1,388 — benefited from a $47 million retail inventory allowance adjustment. That adjustment is tied to prices rising faster than expected in the first quarter, which allowed Carvana to sell through more of its older retail inventory that it had marked down as not being able to sell in the fourth quarter. That boosted retail per-vehicle profit by $593, Carvana said.

Analysts at J.P. Morgan wrote in a research note last week that Carvana's decision to brake on its growth and focus on improving its per-vehicle expenses and profits led to lower cash burn in the near term and a better-than-expected $24 million loss as measured by adjusted earnings before interest, taxes, depreciation and amortization.

But Carvana's interest burden tied to its long-term debt "still leads to a significant drain on liquidity with need to raise capital mid-2024," barring further worsening of the credit and consumer environments in the meantime, the analysts wrote.

Carvana paid roughly $160 million in interest in the first quarter of 2023, and if the company pays that amount each quarter, it is looking at more than $600 million per year in interest expense alone, said Chris Pierce, a research analyst at Needham & Co.

Higher interest payments are tied in part to a $3.2 billion long-term loan with a 10.25 percent interest rate that Carvana took out in 2022 to pay for ADESA U.S., the large auction network it acquired from KAR Global last May. Carvana listed $6.57 billion in long-term debt on its balance sheet at the end of March.

Analysts covering Carvana have long suggested the company needs to rework its debt to make it viable in the long term.

The company had previously proposed that its creditors trade debt for asset-secured notes. But Bloomberg reported last month that creditors holding about 90 percent of Carvana's bonds pitched it on a debt-for-equity swap.

Carvana CFO Mark Jenkins said last week that there haven't been changes to the way the company has historically thought about improving liquidity.

"Generally speaking, we favor asset-based or secured financing, of which, I think, the biggest asset that we have today is real estate — nearly $2 billion of total unpledged real estate assets," Jenkins said. "A little more than half of that is ADESA real estate locations."

In a research note last week, equity analyst Sharon Zackfia at William Blair & Co. noted Carvana could bring in cash by monetizing the ADESA U.S. real estate.

Bloomberg contributed to this report.