Carvana Stock Faces Setback as Valuation Concerns Arise

Carvana stock faced a significant decline today after a series of impressive gains over the past couple of months. J.P. Morgan analysts, recognizing that the stock’s valuation has surged beyond what is justified by improvements in the used-car retailer’s business, downgraded their rating on Carvana to Underweight from Neutral. They set a target price of $10 in their research note.

As a result of this downgrade, Carvana’s shares were down 5.8% in premarket trading, settling at $36.65. Despite this drop, the stock still remains more than five times higher than its value at the beginning of May when it was trading around $7.

Short sellers played a role in the recent surge of Carvana’s stock price. Many were forced to close their bets against the company, causing a short squeeze. S3 Partners, an organization that tracks data on short selling, identified Carvana as a stock that was potentially at risk of a short squeeze earlier this year. Today’s fall in stock price may come as a relief for some, considering that short interest still represents 49% of Carvana’s freely traded shares as of the end of June.

The J.P. Morgan analysts acknowledge the positive developments Carvana has experienced lately, such as reducing its cash burn and significantly raising its earnings outlook. However, they express concern over the current enterprise valuation, which is approximately 35 times its expected operating profit in 2025. Shareholders appear to be placing bets on a stronger return to growth than originally anticipated.

In their research note, the analysts state, “While positioning and funding outcomes could still impact the short-term direction of shares…we believe that valuation will ultimately align with fundamentals and related forward earnings power.”

Additionally, the analysts suggest that Carvana should consider arranging a debt-for-equity swap to take advantage of the surge in its share price. However, Carvana recently canceled a planned $1 billion debt swap after failing to garner the support of investors who held the majority of its nearly $6 billion in unsecured bonds.

In conclusion, Carvana stock faces a setback as concerns regarding its valuation arise. The drop in stock price today signals a possible correction after a period of significant gains. Analysts remain cautious, emphasizing the need for valuation to align with the company’s fundamental performance and future earnings prospects.