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The stock price has risen by more than 51% year-to-date, and certain analysts remain optimistic about its prospects, but there’s cause for concern given a changing economic environment. I am bearish on this stock. (See CVNA stock charts on TipRanks)
Economic Change
The Conference Board estimates that in Q3, real GDP growth for the U.S. will come in at 7%, but that number is expected to drop to 2.9% in Q4. The real consumer spending rate is expected to fall from 4% to 3.9% as well in that time frame, while core inflation is predicted to rise by another 0.3%.
These factors affect Carvana in a couple of manners. The first is decreasing demand for vehicles as they become less affordable. The second is the potential decrease in loan demand, which might stunt Carvana’s loan-portfolio growth.
As economic factors become more unfavorable to the market, risk becomes priced in — meaning that investors demand higher returns per unit of risk. As risk gets priced into the market, companies with poor fundamental aspects usually get shoved aside, which may happen to Carvana.
Debt Concerns
When economic growth factors cool down, growth stocks at unreasonable prices tend to get hit the hardest. As mentioned, Carvana simply doesn’t have the fundamentals to justify its current price.
Short-term debt pile-up usually suggests fragilities within a company. Carvana’s short-term debt increased by a staggering amount in the past quarter. As well, the company has placed a bet on turning in positive operating earnings for the first time ever, by expanding its business with a $750-million bond offering.
Since its inception, Carvana’s interest-coverage ratio has never been positive. This means that they’re gambling on their new debt issuance to increase earnings in a slowing economy. If the gamble doesn’t pay off, they’ll most likely have to either sell assets or issue new shares, which will dilute shareholders’ holdings.
Shareholder Value
Carvana’s valuation doesn’t make the slightest bit of sense. The stock’s outperforming the market, but the earnings-per-share remains negative, with a slight upward trajectory due to excessive insider selling.
If that’s not enough, Carvana’s PEG ratio has held a negative correlation with the stock price since the tech-buying frenzy started in 2020. The PEG ratio measures the stock price relative to the company’s growth, which means that poor fundamental valuation metrics can’t be justified by any potential of hypergrowth.
According to Carvana’s price-to-sales ratio, the stock is overvalued by 2.96 times, during a period in which the company has most likely experienced peak sales growth.
It’s almost a certainty that Carvana will file for an additional share offering if it can’t turn an operating profit in the next quarter, and shareholders could experience significant losses as a consequence.
Wall Street’s Take
Overall, the consensus is that Carvana is a Strong Buy, based on 13 Buys and four Holds. The average CVNA price target of $392 implies 9.6% upside potential to current levels.
While Wall Street is generally bullish about Carvana, Alexander Potter of Piper Sandler and Rajat Gupta from J.P Morgan recently downgraded the stock. I anticipate many more downgrades from analysts as the optimism surrounding the company’s latest earnings beat fades.
Disclosure: On the date of publication, Steve Gray Booyens had no position in any of the companies discussed in this article.
Disclaimer: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities.
