Carvana sells an inventory of around 15,000 used cars direct to consumers in over 100 U.S. cities via its website, according to The Motley Fool. Consumers do not interact with salespeople, don’t haggle over price, and complete financing and paperwork online. Ultimately, Carvana delivers purchased vehicles to consumers’ homes or it allows them pick them up at an automated garage that looks like a giant used car vending machine.
It sounds like a great value proposition for consumers and the company is growing fast.
So why is Carvana so heavily shorted? I think investors are worried about its inability to make a profit and its voracious appetite for cash as it grows. But this is a stock that seems to be burning those who bet against it.
While I have no financial interest in the securities mentioned in this post, Carvana looks like the kind of company that is in no hurry to reward short sellers by failing to beat and raise in the quarters ahead.
Short interest in Carvana is a whopping 51% of float. The bear case against Carvana consists of four key arguments:
While doubling every quarter, Carvana has never made money and it burns through cash.
Let’s start with the good news. Carvana’s third quarter 2019 report beat revenue expectations and expected guidance for 2019. On November 6, Carvana reported revenue of $1.1 billion — $104 million more than Wall Street expected and about double the previous year’s figure. And Carvana raised its guidance for the year to a range of $3.85 billion to $3.95 billion, an increase in the range of 97% to 102%, according to Investors Business Daily which noted that Carvana’s new guidance was up from an earlier range between $3.6 billion and $3.7 billion.
But Carvana reported a so-called adjusted loss of 78 cents per share nearly twice the 40 cents a share loss that Wall Street expected. And its $39 million net loss for the quarter was 144% more than the loss it reported the year before, according to its third quarter 2019 report. Carvana has yet to earn a profit.
What’s worse, Carvana’s cash burn rate from operations is soaring. For the first nine months of 2019, Carvana reported about $435 million in net cash used up in operations — up 65% from the year before.
It raised $500 million by selling stock and borrowing $250 million at nearly 8.9% interest – it’s a CCC-rated credit.
In May 2019, Carvana tried to bolster its cash position by raising $500 million. $270 million would come from selling 3.5 million Series A common shares. Another $250 million would come from issuing more 8.875 percent senior notes due in 2023 in a private offering, according to Automotive News.
In September, SeekingAlpha noted that the second highest market capitalization company — behind Uber — with CCC-rated debt was Carvana. That junk rating — combined with the high interest rate on the debt could be making investors nervous.
Morgan Stanley rated the stock underweight – due to concern about its path to profitability.
In May, Morgan Stanley analyst Armintas Sinkevicius maintained an “underweight” rating — equivalent to a “sell.” Sinkevicius estimated that the additional capital would provide Carvana with enough cash to operate through the second half of 2020. He wrote that the company would take longer than bulls think “to disrupt the used-car dealership model” and that Morgan Stanley was “concerned about profitability in the meantime,” according to Automotive News.
Carvana shares are grossly over-valued compared to its rivals — such as CarMax.
Carvana remains one of the most heavily shorted stocks on the NYSE — in part due to its high valuation compared to CarMax (a publicly-traded rival that leads the U.S. in used car sales). Carvana’s price/sales ratio of 4.05 times its most recent 12 months’ sales is some five times more than Carmax’s 0.8. Meanwhile, its 12% gross margin is lower than CarMax’s 14%. And whereas Carvana posted a 4% negative net margin, CarMax’s net margin is 5%.
What Is Levitating Carvana’s Stock?
If this sounds like an open and shut case for shorting Carvana, you have another thing coming. To be fair, investors dumped Carvana stock — sending it down 10% — after it reported its third quarter results due to concerns about its lack of profitability. But as of November 25, Carvana shares were at an all time high of $91.32 — up 709% from its $13.50 IPO price in April 2017.
The thing levitating Carvana’s stock is its rapid revenue growth. Between 2016 and 2018, its sales grew at a 130% compound annual rate from $370 million in 2016 to $1.96 billion in 2018, according to Morningstar.
Customers seem to like Carvana. 2,042 reviews on Trustpilot give Carvana 4/5 stars. 71% of the ratings are great or excellent, while 19% are bad. Lots of reviews rave about the ease of buying, paying for, and picking up the vehicle. One buyer in Northern Wisconsin suffered through a “logistical nightmare” when it botched the pickup in Chicago.
As long as it keeps beating revenue expectations and raising revenue guidance every quarter, I think its shares will go up. And that high level of short interest is adding fuel to the melt-up fire.
Eventually, the shorts will be right when Carvana fails to beat and raise. In the meantime, short sellers could keep getting squeezed.