Carvana Co. (NYSE:CVNA) is set to release its highly anticipated second-quarter results report on August 4. In a piece by seekingalpha in April, investors were informed that it was still too early to add exposure. CVNA has dropped another 73% since our last update, dramatically outperforming the SPDR S&P 500 ETF’s (SPY) -7% return over the same period.
However, we are prepared to raise our rating. We believe CVNA’s hammering is about over, as it has reached its long-term low. Over the last two months, it has also displayed positive bottoming indications, indicating severe selling weariness. Despite the risk of worsening macroeconomic conditions, given recent US quarterly GDP statistics indicating a technical recession, we urge investors to look ahead (since markets are forward-looking). We also noticed that the consumer discretionary ETF (XLY) has reached it’s long-term low and appears poised to halt further dropping.
Our valuation model implies that CVNA’s valuation is reasonable even for a speculative stock. As a result, investors who have been waiting since it’s August 2021 highs may want to consider boosting exposure. Furthermore, we believe that a potential re-rating in XLY might support the sector as a whole, including well-beaten speculative equities like CVNA. As a result, we upgrade CVNA from Hold to Speculative Buy.
Carvana’s Battering Is Justified
Carvana’s first-quarter results revealed that the company suffered a meaningful impact as consumers reduced their discretionary spending even further. With historic inflation rates, the market has reasonably predicted that companies such as Carvana would be significantly impacted, exacerbated by its unprofitability. CEO Ernest Garcia also mentioned the following in a June conference (edited):
We began to see some affordability concerns in Q4. Car prices have risen once more. Interest rates had just begun to rise, and Omicron also hammered us. As a result, we had less volume than expected. Then, in Q1, things went very differently than predicted. I believe that affordability concerns emerged, particularly for lower socioeconomic segments of the economy. As a result, we witnessed much less volume than expected in Q1. But we developed a machine to handle a lot more sales, and our SG&A per unit was much greater. (42nd Annual Growth Stock Conference, William Blair)
Management Remains Committed To Achieving Profitability
Despite the harsher macro environment and increasing interest load from the ADESA acquisition, management is confident that it has a path to profitability. The company is committed to lowering its SG&A spending per unit as it expands. Nonetheless, the business emphasized that it is still very much dependent on the company’s ability to execute as it continues to acquire market share.
We consider management’s statements to be positive. We like how management provides insight on its near-term and intermediate profitability guideposts rather than simply lumping them together in a so-called long-term model (how long is long-term?). As a result, we can continuously review management’s execution against its guidance, which allows us to determine whether our assumptions are still relevant.
The consensus estimates (bullish) back the management’s comments. Carvana’s profitability cadence is predicted to rise from its low point in the second quarter as it generates significant operating leverage through FY23. However, those large income gains before its catastrophic bust are likely over, even though it is projected to stay resilient.
As a result, we recommend investors alter their expectations for CVNA regaining its all-time high by applying a market-outperform hurdle rate of 25%, which we believe is suitable for a growth stock. We also selected a 2.5% FCF yield to provide some growth cushion for CVNA. As a result, we assumed a 1% FCF margin (lower than the Street’s estimate). We required Carvana to produce a TTM revenue of $20.66B. We feel our sales target is reachable based on the increased consensus forecasts.
However, it is largely dependent on management’s ability to execute its profitability strategy, which investors must carefully assess.
Carvana Stock Has Reached Its Long-Term Bottom
On CVNA’s long-term chart, we also noticed positive price activity. CVNA re-tested its long-term support ($22) in June and has held its bottom tenaciously in July, as seen above. We also witnessed a bear trap (meaning that the market forcefully prevented more selling downside), which bodes favorably for the market’s bottoming process. Furthermore, we noted a long-term bottom in XLY’s long-term chart, indicating that a sector re-rating is imminent. As a result, we are optimistic about CVNA’s long-term bottoming process and feel the worst is behind us.
Is CVNA Stock A Buy, Sell, Or Hold?
We upgrade CVNA from Hold to Speculative Buy, with a $40 intermediate price objective (PT) (a potential upside of 37.2% ). Despite the coming recessionary challenges, investors are encouraged to assess the market’s forward-looking perspective. Investors should also evaluate management’s near- and medium-term profit execution against its forecast to test the validity of their thesis and value models.
Nonetheless, considering Carvana’s record of unprofitability, investors are urged to include an appropriate margin of safety in their model parameters. However, we believe the worst is past, notwithstanding our continued expectation of short-term volatility.
Featured Image: Megapixl @Jetcityimage
