Based on recent headlines, it’s clear the situation keeps getting worse for Carvana (NYSE:CVNA). So then, why are so many still dabbling in CVNA stock?
Buzz surrounding CVNA’s short squeeze potential, for one. Short-term traders have cycled in and out of the stock in recent weeks for this reason.
However, some speculators have dived into the online automotive retailer’s shares for another reason. They are wagering that a certain bull case for the stock plays out, producing a significant payoff. It all has to do with a situation, somewhat similar to this one, with another moribund automotive stock back in 2020 and 2021.
But while the story with Carvana right now may seem similar, don’t count on this tale having a similarly-profitable ending.
Instead of creating a massive windfall for risk-hungry investors, those buying this stock today are far more likely to experience a near-total or total loss.
CVNA Stock and the Bull Case
As you may have guessed, the “moribund automotive stock” I was referring to above is Hertz Global Holdings (NASDAQ:HTZ). You may remember how, shortly after the onset of the pandemic in 2020, the leading auto rental company filed for Chapter 11 bankruptcy.
Chapter 11 bankruptcy typically represents a “game over” moment for common shareholders. In most Chapter 11 cases, creditors such as bondholders take ownership of the reorganized company. Holders of the bankrupt firm’s common stock are wiped out.
Nevertheless, this didn’t stop many small retail investors from buying the stock right after its bankruptcy filing, in the hopes that investors would receive a sliver of equity worth more than their purchase price. In 2021, this bull case played out, sparking a wave of high speculation on financially-troubled companies. That brings us back to CVNA stock.
Despite the company’s high cash burn and heavily-leveraged balance sheet, shares have managed to double in price since January. This was partly due to the short-squeeze excitement, but also to investors betting that CVNA is the next HTZ.
However, taking a closer look at the facts and circumstances with Carvana, it’s hard to see a profitable outcome emerging.
Don’t Count on a Hertz-Like Outcome
As detailed in a recent Bloomberg article, there are plenty of similarities between Carvana in 2023 and Hertz in 2020. Again though, this does not indicate that CVNA stock will experience a favorable turn of events in the coming year.
Yes, like Hertz three years back, an unexpected downturn has left Carvana in a precarious financial position. Due to cratering used car demand, this once high-flying digital-first used car dealer has experienced a serious contraction in revenue.
Last quarter alone, revenues sank 24% compared to the prior year’s quarter. This sharp drop in revenue has led to ballooning net losses. The company lost $806 million during Q4 2022, versus losses of $89 million in Q4 2021. With just $434 million in cash, against $7 billion in debt and lease liabilities, Chapter 11 is a real possibility for Carvana.
However, a Hertz-like outcome is likely out of reach, for one key reason. A fast recovery in rental car demand, and the 2021 used car bubble, enabled the car rental firm’s underlying value to bounce back. That left enough meat on the bone for common shareholders to profit. In contrast, Carvana’s underlying value is likely to continue contracting.
Even as Carvana anticipates slight improvements to revenue, and expects a $100 million reduction in operating costs, during the current quarter, chances are the company is continuing to burn through a significant amount of its cash position.
As analysts at JP Morgan have argued, used car demand is expected to keep dropping. With many pointing to its negative shareholder equity (currently at around $1 billion) continuing to rise, if Carvana files for bankruptcy, forget about common shareholders coming out ahead. Creditors may not even get paid in full.
In the event Carvana avoids bankruptcy, investors buying the stock today could still lose. Avoiding Chapter 11 will likely require a capital infusion, which will severely dilute existing shareholders.
With a very high chance the bull case fails to play out, avoid CVNA stock at all costs.
CVNA stock earns a D rating in Portfolio Grader.
On the date of publication, neither Louis Navellier nor the InvestorPlace Research Staff member primarily responsible for this article held (either directly or indirectly) any positions in the securities mentioned in this article.