While the Fed's high interest rate regime hasn't done much to slow down the current bull market, investors still celebrated last week's historic interest rate cut from the Federal Open Market Committee (FOMC). The jumbo rate cut of 50 basis points is expected to benefit multiple sectors of the economy that rely heavily on short-term debt to finance their growth, such as real estate, clean energy, and startup growth companies across numerous industries. As the cost of debt declines in a lower interest rate environment, it's easier for companies to fuel their expansion plans, resulting in higher revenue and earnings over time.
One outperforming growth stock that could benefit from interest rate cuts is Carvana (CVNA). Let’s see if the stock is a good buy right now.
Carvana Stock Has Gained Over 300% in the Past Year
Carvana (CVNA) is an online platform where customers can buy and sell used cars. Valued at a market cap of $35.2 billion, Carvana has taken investors on a roller-coaster ride since its initial public offering (IPO) in April 2017. The company’s IPO was priced at $15, and the stock surged to an all-time high of almost $400 in August 2021, primarily due to strong demand for used cars amid the COVID-19 pandemic.
However, its weak financials, lower profit margins, higher interest rates, and a sluggish macro environment dragged the stock to just $4 by late 2022, and the company narrowly avoided what many thought was a near-certain bankruptcy filing in 2023. Today, CVNA stock trades at $175, up more than 317% in the past year.
Carvana stock has surged in recent months due to its steady growth in sales and improving profit margins. In Q1 of 2024, the company increased its shipments by 16% year over year to 91,878 units; in Q2 of 2024, unit volume rose 33% to 101,440. While sales of cheaper vehicles were higher in Q2, Carvana increased its sales by 15% year over year.
Additionally, its gross profit per unit (GPPU) rose by 28% from $2,666 to $3,421 in the last 12 months. Carvana has increased its gross margins from 9.2% in 2022 to 18.8% in the previous 12 months. Its operating margin has widened to 18.8%, compared to a negative margin of 10.3% in 2022.
Is Carvana Stock a Good Buy?
In the last 12 months, Carvana has reported an operating income of $406 million. However, its interest expenses have totaled $664 million, compared to $176 million in 2021.
The company’s free cash flow in the last four quarters has improved to $738 million compared to a free cash outflow of $3.1 billion in 2021. In Q2 of 2024, Carvana reported a free cash flow of $332 million, while its interest expenses totaled $173 million. We can see that Carvana is now generating enough free cash flow to meet its debt obligations, driving investor optimism higher.
Despite its low-margin business, investors are bullish on Carvana's long-term prospects. For instance, approximately 36 million used cars were sold in the U.S. last year, per Cox Automotive, which shows that Carvana currently owns a market share of less than 1%. Carvana is part of a highly fragmented industry and is positioned to gain massive traction due to its easily accessible online platform.
That said, investors should note that interest expenses accounted for 67% of the company’s operating income, leaving little room for error if the economy enters a recession and the auto sector enters a cyclical downturn.
Bank of America is Bullish on Carvana
BofA Securities (BAC) analyst Michael McGovern just reinstated a “buy” rating and $185 price target on CVNA, arguing that the auto sector is ripe for online disruption as online sales account for just 2% of total used car sales in the U.S. The analyst forecasts the used-car market at $800 billion, and explains that Carvana’s acquisition of ADESA, a car auction platform, provides a unique competitive advantage and new opportunities.
McGovern also stated that Carvana’s improvements in unit economics and an improving cost base make it less vulnerable to future demand spikes. He expects Carvana to end 2032 with annual sales of $50 billion, gross profits of $13 billion, and an operating profit of $9 billion.
BofA's bullish rating fits in with the analyst consensus on CVNA stock, which is a “moderate buy."
Out of the 20 analysts covering CVNA stock, seven recommend “strong buy,” one recommends “moderate buy,” 11 recommend “hold,” and one recommends “moderate sell.”
The average 12-month target price for CVNA stock is $157.44, a discount to Monday's closing price. McGovern's newly set price target of $185 implies expected upside of 5.6%.
On the date of publication, Aditya Raghunath did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
