Carvana faces liquidity constraints due to high debt and rising interest rates

Few companies have been hit harder by rising interest rates than Carvana. The company’s interest expense nearly doubled earlier this year when it was paid to finance an acquisition. The cost of financing car purchases has risen by three-quarters this year, and some of his properties have fallen in value. Meanwhile, car buyers are holding back on their purchases in the hope that interest rates will fall.

In a memo to Carvana employees announcing the layoffs, Chief Executive Ernie Garcia III blamed an uncertain economic environment, which he said was particularly tough for fast-growing companies that sell products made by higher-end companies interest rates are affected. “We couldn’t predict exactly 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 that disrupting the auto industry is not easy. “We’ve seen many e-commerce companies get written off early in their journey just to become market leaders. We want to follow suit,” said a spokesman. Earlier this month, Carvana executives said cash flow and profitability are now the strategic focus.

Carvana became very popular with car buyers, with heavy advertising and trade-free cars delivered to their doors. Investors bought in, sending the stock up more than sixfold. The stock is down more than 97% from its peak last year. Carvana’s bonds are trading at distressed levels.

“They built infrastructure across the business assuming the growth would be there,” said Daniel Imbro, a managing director at Stephens Inc.

Rating agency S&P Global Ratings warned that Carvana’s liquidity was likely to erode faster than expected and changed the outlook on Carvana’s CCC+ rating to negative earlier this month. The company’s reputation for raising more money from stock and bond investors has deteriorated.

Less than a year ago, Carvana was still trying to keep up with demand. In February, an agreement was reached to buy a car auction business that would help increase inventories. However, car sales slowed.

On the day the deal closed in May, Mr Garcia said it had overshot growth, laying 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 nearly doubled Carvana’s annual interest expense, reflecting investor fears of a recession and rising inflation.

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

Carvana made big profits selling its auto loans to yield-hungry investors. Profits from the loans help Carvana offset the losses it makes selling cars. As investors became more choosy about these securities in the spring, Carvana instead sold many of the loans to Ally on less favorable terms. Book gains on loan sales fell by about a third in the third quarter compared to the prior-year period.

Garcia told analysts in a call Nov. 3 that the company would continue to cut costs and that it had access to about $4 billion in liquidity in addition to its $316 million in cash and a few other assets. The amount includes what it can borrow on lines of credit to buy cars and make loans. It also included around $2 billion worth of real estate, which is not typically considered a liquid asset.

The company’s chief financial officer said Carvana could borrow for the properties, which include the land it bought earlier this year. Previously, the company raised around $500 million by selling some locations where cars were inspected and then leased back for 20 or 25 years.

The move could work, analysts said, but it would also incur additional costs. They said any real estate deals would likely be piecemeal over time or involve large rent payments due to Carvana’s credit problems.

Scott Merkle, a managing partner at SLB Capital Advisors, which specializes in sale-leaseback transactions, said the space’s long-term leases are generally dependent on financially sound tenants who can be expected to make their rent payments for years to come . He said general seller conditions in this market have deteriorated due to higher interest rates, but sale-leasebacks still offer a better cost of capital for companies than other financing.

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

Carvana said it is exploring ways to get more out of its auto sales, such as: B. accepting payments before delivery and allowing customers to collect cars at its vending machines.

“We have a bunch of committed liquidity. We have a lot of real estate and I think we feel that puts us in a good position to weather this storm,” Mr. Garcia told analysts on the Nov. 3 conference call.

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

Write to Margot Patrick at [email protected] and Kristin Broughton at [email protected]