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Carvana suffers big loss on first drop in sales

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Carvana co

CVNA -9.11%

A pandemic star who has suffered during the recovery reported its first-ever drop in quarterly sales and said it will raise capital as the online used-car dealership grapples with operational disruptions and tougher economic conditions.

Carvana shares fell as much as 24% after the close on Wednesday before recovering; They fell 9% in regular trading. Netflix, another pandemic star, fell 35% on Wednesday. Carvana said it plans to sell $2 billion of common and preferred stock, in part to fund its proposed acquisition of ADESA US

Carvana said it sold 105,185 cars to retail customers in the first quarter, or about 7,800 fewer than the previous quarter, although up year-on-year. Net loss increased to $260 million compared to $36 million a year earlier. Gross profit per unit — one of the company’s preferred earnings measures — fell to $2,833 from $3,656 a year earlier.

In the past six months, the tailwinds that have propelled the company into rapid growth have turned into headwinds. Rising interest rates, falling used-car prices, inflation-averse consumers, and a dwindling appetite for debt have turned Carvana’s ambitious growth goals on its head.

The retailer, which has just over $3 billion in long-term debt, said it is no longer providing financial guidance for the year due to rising interest rates, rising fuel prices and macroeconomic uncertainty, all affecting the used car market. It said in February that it expects full-year retail sales of more than 550,000 cars.

“Over the next few quarters, we expect to better align revenue with cost levels through a combination of higher sales and cost efficiencies,” the company said.

Analysts had expressed doubts whether the company could still achieve its sales targets. If they are absent, Carvana’s cash position could come under further pressure. The company is still burning cash after about 10 years in business.

Tempe, Ariz.-based Carvana has grown rapidly over the past two years, roughly doubling its quarterly sales volume since spring 2020 as more consumers shop online. But the company has struggled with backlogs in its logistics network and remanufacturing centers in recent months, partly due to labor shortages stemming from the Covid-19 surge caused by the Omicron variant. In response, it reduced consumer purchases of vehicles and limited available inventory on its website.

Inflationary pressures dampened industry-wide selling during the quarter, analysts said. Soaring car prices, which have propped up used-car dealers’ profits over the past year, have become a drag on some consumers, who are also spending more on gasoline and other household items.

“It’s not just a supply situation for these guys that is holding back their growth. It’s also the demand situation, and that’s something not every investor appreciates right now,” said Seth Basham, an analyst at Wedbush Securities.

The Mannheim used car price index lost a seasonally adjusted 3.3% in March compared to February, but was still 24.8% above the previous year’s value. Vehicle prices are expected to remain high throughout 2022 as the industry grapples with inventory constraints, including a semiconductor shortage.

Prospective customers looking to sell their cars to Carvana told The Wall Street Journal that the company recently dropped offers they had already accepted for their cars, in several cases slashing them by thousands of dollars while it citing an error in their pricing algorithm. The company said it remains committed to “continuous improvement” and enhancing the customer experience.

Carvana normally reports later in the earnings season but said last week it decided to report on Wednesday to help close its proposed $2.2 billion acquisition of used-car auction company ADESA US. The deal is expected to close in May, the company said.

One reason Carvana is taking a hit is the way it accounts for sales of auto loans that it wraps in securities. Carvana books instant profits, unlike competitors who book them over time. Such accounting has helped the company grow its revenue when consumer credit — and investor demand for auto loan-backed securities — was particularly strong.

But conditions in the securitization market have recently changed. Investors are demanding higher yields for securities backed by riskier consumer loans. They begin to worry that rising interest rates and inflation could affect borrowers’ ability to pay.

Carvana issued two securitizations in March — one with prime auto loans, the other with subprime loans — totaling about $1.49 billion, according to Finsight, a financial data provider. In both cases, Carvana booked less profit on the deals than in the past because investors were demanding higher yields than the deals Carvana made in the fourth quarter, according to data provided by Wedbush.

Clayton Triick, senior portfolio manager at Angel Oak Capital Advisors, said his firm has become more cautious about securitizing subprime autos in recent months as they demand higher yields and expect higher default rates. Angel Oak invested in one of Carvana’s securitisations during the first quarter, he said.

Overall, Angel Oak has been more focused on buying asset-backed securities in the secondary market than directly from issuers, Mr. Triick said. That’s because the auto loans backing those bonds are older, meaning they were issued when auto prices were lower, and also have a proven track record of repayment, he said.

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Increased investor caution in the securitization market weighed on Carvana’s earnings for the quarter. Rajat Gupta, an analyst at JPMorgan Chase & Co., estimated in March that the company’s loan securitization profit margin — a metric that compares proceeds received to the total value of loans sold — rose from 9.1% to 4.4% in the first quarter % declined the previous quarter.

The offering of the shares came as a surprise to investors as Carvana said it had received committed funding for the ADESA deal. Chief Executive Ernie Garcia III and his father Ernie Garcia II said they would buy a portion of the newly issued stock.

The acquisition of ADESA, a used-car auction company that’s an industry fixture, came as a surprise to Carvana, which says it’s aiming to turn car sales around. Carvana executives said in February that the deal would increase vehicle processing capacity and expand the logistics network, in addition to auction capacity.

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write to Kristin Broughton at Kristin.Broughton@wsj.com and Ben Foldy at Ben.Foldy@wsj.com

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