After pulling back during February and early March, Carvana (NYSE:CVNA) shares have been on the rise over the past few weeks. With its move back to around $9.50 per share, CVNA stock is again one of this year’s top performers. This year, the stock has more than doubled. That’s some strong performance.
That said, I think speculators are rolling the dice with this online used car retailer. Some speculators are clearly approaching CVNA stock it as a trade. Others have a longer time horizon. Yet, while their reasons for buying differ, most such investors are making a relatively similar bet. That is, that Carvana successfully rides out the current used car market downturn.
So, with the market growing increasingly bullish about the company’s prospects, should you join the wave? Not so fast. Further upside may be limited, and downside risk remains very elevated, despite improved sentiment.
Why CVNA Stock Has More Than Doubled Since January
At the end of 2022, tax loss harvesting, plus elevated fears about possible bankruptcy, pushed Carvana shares down into penny stock territory. With the start of the new year, pressure from tax-related selling dissipated. Bankruptcy fears also eased, as the company has made headway in assuaging these concerns (more on that later).
However, these are perhaps not the reasons why CVNA stock doubled on a year-to-date basis. Again, investors and traders have dived back into Carvana for multiple reasons.
Many traders are in this stock as a near-term trade, wagering that perceived improvements in its prospects will help drive a short-squeeze. Investors looking at the stock as a longer-term investment are bullish that Carvana (a money-loser even during the boom times of 2021) will finally swing to consistent profitability once the used car market rebounds. In turn, they are justifying a move back to higher prices.
Still, it’s questionable whether there is much upside from here. In early March, when CVNA stock was trading for prices below current levels, I argued that a complete turnaround was already priced into the stock. Worse yet, despite the latest news, the company’s debt issue is far from resolved.
High Debt, High Risk
Over the past few months, statements and actions from management have helped reduce perceived bankruptcy risk with CVNA stock. For instance, in February, Eddie Garcia III, Carvana’s Chairman/CEO, made comments on an earnings conference call that implied the company had plenty of assets it could borrow against, to sustain further losses without raising additional equity.
More recently, Carvana has announced a debt exchange offer, which could reduce its outstanding unsecured debt, as well as the annual interest expenses on this debt. In this same announcement, the company also released updates to guidance, which imply that its reduction efforts are starting to make an impact, narrowing losses.
This progress notwithstanding, bankruptcy risk, or at the very least dilution risk, still cannot be ignored with Carvana. Even if the company has reduced quarterly losses to between $50 million and $100 million, that still represents a high cash burn.
Accordingly, even if the company is reducing its annual interest payments with this exchange, expect this figure to stay high. Estimates call for the businesses to lower interest expenses by $100 million, but Carvana’s interest expenses totaled $486 million in 2022.
Forget about whether there’s more gas in the tank for Carvana. The real question is whether management can keep this company on the road and out of the scrap yard. A Carvana comeback is priced in at present price levels, and then some.
At the same time, investors continue to ignore that the company is more likely to need an additional capital infusion, considering Carvana’s negative operating income and still-high levels of interest expenses. Otherwise, there’s a strong chance that the company will have to file for Chapter 11 bankruptcy.
Carvana has a market cap of $1.8 billion but many billions more in outstanding debt. The amount of cash the company will ultimately need to raise could result in severe shareholder dilution.
Considering the risks, and ignoring the current optimism, investors should take a hard pass on CVNA stock.
On the date of publication, Thomas Niel did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.