Carvana Faces Cash Crunch From High Debt, Rising Interest Rates

Carvana Co.

CVNA -3.13%

the used-car dealer that was a pandemic winner, is rushing to conserve cash as once-plentiful financing options dry up and business deteriorates.

On Friday, Carvana laid off about 1,500 people, its second round in six months. Its weakening finances mean raising funds would be difficult and costly, and it could run out of cash in a year, analysts say.

Few companies have been hit harder by rising interest rates than Carvana. The company’s interest expense nearly doubled early this year when it paid up to get financing for an acquisition. Its cost to finance car purchases is up by three quarters this year, and some of its real estate has lost value. Car buyers, meanwhile, are holding off purchases in the hope that rates fall.

In a memo to Carvana’s employees announcing the layoffs, Chief Executive Ernie Garcia III blamed an uncertain economic environment that he said was particularly tough on fast-growing companies that sell products affected by higher interest rates. “We failed to accurately predict how this would all play out and the impact it would have on our business,” he said.

The company said it has millions of satisfied customers, and disrupting the auto industry isn’t easy. “We have seen many e-commerce companies written off early in their journey only to become market leaders. We plan to follow suit,” a spokesman said. Earlier this month, Carvana executives said cash flows and profitability are the strategic focus now.

WSJ’s Ben Foldy explains the factors that helped drive Carvana’s growth and why investors are now questioning its future. Illustration: Preston Jessee

Carvana became wildly popular among car buyers, with heavy advertising and haggle-free cars delivered to their doors. Investors bought in, driving the shares up more than sixfold. The stock has fallen more than 97% since its peak last year. Carvana’s bonds are trading at distressed levels.

“They built an infrastructure across the enterprise with the assumption that the growth would be there,” said Daniel Imbro, a managing director at Stephens Inc.

The ratings firm S&P Global Ratings warned that Carvana’s liquidity likely would erode faster than expected, and changed the outlook on its CCC+ rating to negative earlier this month. It said the company’s standing to raise more cash from stock and bond investors has deteriorated.

Less than a year ago, Carvana was still trying to keep up with demand. In February, he agreed to buy a car-auction business that would help stock inventory. Car sales slowed down, though.

The day the deal was completed in May, Mr. Garcia said it had overshot growth and laid off 2,500 workers. Days earlier, it had issued a $3.275 billion bond with a 10.25% coupon to fund the purchase. The high coupon almost doubled Carvana’s annual interest expense and reflected investors’ fears of a recession and rising inflation.

Carvana CEO Ernie Garcia III and his father, Ernest Garcia II, when the company went public in 2017.


Photo:

Michael Nagle/Bloomberg News

Carvana thrived when interest rates were low because it could borrow cheaply to buy cars and make loans to customers. Its credit line from Ally Financial to buy cars had an average 2.6% interest rate last year, compared with 4.5% at the end of September. Ally required Carvana to set aside 12.5% ​​of the amount borrowed as of late September, up from 7.5%, further tightening its cash situation. An Ally spokesman declined to comment.

Carvana earned big profits selling its car loans to investors who were hungry for yield. Gains from the loans help Carvana offset the losses it makes selling cars. When investors turned choosier on these securities in the spring, Carvana sold many of the loans to Ally instead, on less-favorable terms. The gains it books from loan sales fell by around one-third in the third quarter from the year-earlier period.

Mr. Garcia told analysts on a call Nov. 3 that the company would maintain cutting costs and that it has access to around $4 billion in liquidity, in addition to its $316 million cash and some other assets. The amount includes what it can borrow on credit lines to buy cars and make loans. It also included around $2 billion of real estate, which isn’t typically considered a liquid asset.

The company’s chief financial officer said Carvana could borrow against the real estate, which includes sites it bought this year. It previously raised around $500 million from selling some sites where it inspects cars and then leases them back for 20 or 25 years.

That step might work, analysts said, but would also add expenses. They said any real-estate deals would likely occur piecemeal over time, or involve high rent payments because of Carvana’s credit troubles.

Scott Merkle, a managing partner at SLB Capital Advisors, which specializes in sale-leaseback transactions, said the long-term leases in the space generally rely on financially sound tenants that can be expected to make their lease payments for years. He said that overall conditions for sellers have softened in that market because of higher interest rates, but that sale-leasebacks still provide a better cost of capital for companies than other financing.

Carvana said it is testing ways to make more sales from its car, such as having customers pick up cars from its vending machines.


Photo:

USA TODAY NETWORK/Reuters

Some Carvana-leased properties have received a tepid response on the market. A 12-story “flagship” car-vending machine in Atlanta that Carvana sold and leased back in December was relisted this summer. It is still on the market, and the asking price has since been lowered.

Carvana said it is testing ways to make more sales from its car, such as taking payment before delivery and having customers pick up cars from its vending machines.

“We’ve got a bunch of committed liquidity. We’ve got a bunch of real estate, and I think that we feel like that puts us in a good position to ride out this storm.” Garcia told analysts on the Nov. 3 call.

—Ben Foldy, Will Feuer and Ben Eisen contributed to this article.

Write to Margot Patrick at margot.patrick@wsj.com and Kristin Broughton at Kristin.Broughton@wsj.com

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