Carvana has now reported two profitable quarters. Time to buy?

Carvana (CVNA -7.42%) has done the unthinkable. The company wanted to reshape the fragmented used car market by handling transactions and financing online. It then completes the transaction at the customer’s home or at pickup and delivery locations, some of which are called “car vending machines.” This reduces the high overhead costs of running car dealerships like its competitor CarMax.

After being on the brink of bankruptcy, the company was saved by a debt restructuring. The company now reports earnings before interest, taxes, depreciation and amortization (EBITDA) and positive net income for the first two quarters of 2024.

Thanks to this recovery, retail stocks are up more than 2,900% since the start of 2023. But does this recovery mean it’s safe for investors to buy?

Carvana’s second quarter report

Rising auto sales have played a key role in Carvana’s success. In the second quarter, net sales and operating income of $3.4 billion rose 15% from the year-ago level. This lagged behind the 33% increase in auto sales, an industry currently struggling with falling used car prices.

The company was also able to limit the growth in operating costs to less than 1%. This led to a positive operating result – so positive that even after interest expenses of $173 million, Carvana made a net profit of $18 million. In the same quarter last year, the company had lost $58 million.

In addition, Carvana has managed to maintain positive free cash flow, generating $415 million in the first half of 2024. This is a slight improvement from the same period last year when it generated $393 million, a factor that may have contributed to the stock’s recovery over the past year.

The company was vague about its outlook for the rest of the year, expressing only expectations of sequential growth in auto sales and positive EBITDA. It expects EBITDA of $1 billion to $1.2 billion in 2024, up from $339 million last year. However, since EBITDA does not include interest, taxes, depreciation or amortization, it is unclear whether this will mean positive net income.

Remaining dangers

The optimism surrounding Carvana’s recovery has made the stock relatively expensive. Even if you use recent earnings to value the company on a price-to-earnings (P/E) basis, the price-to-sales (P/S) ratio of 2.2 is deceptively high when you consider the average P/S ratio of 1.4 over the past five years.

In addition, the economic situation is uncertain. If car sales fall to last year’s levels or below, Carvana would likely report net losses again, a prospect that could jeopardize the company’s recovery.

In addition, the company’s debt load remains a problem despite the restructuring. Total debt fell from more than $6 billion at the end of 2023 to $5.5 billion at the end of the second quarter. Still, that’s a lot for a company with only $115 million in equity. Moreover, interest rates on most of that debt are between 12% and 14%.

Fortunately for Carvana, none of its long-term debt comes due before 2028. Still, the company generated $415 million in free cash flow in the first six months of 2024, so it needs to keep up that pace to significantly reduce its debt and hopefully refinance the rest at lower interest rates.

Continue to avoid Carvana stock

Under these conditions, Carvana remains a high-risk stock that most investors should avoid. Admittedly, the company has shown surprising resilience in recovering from the brink of bankruptcy and becoming operationally profitable, and the declining total debt is an encouraging sign.

However, the turnaround could still be undone by falling sales. In addition, the price-to-earnings ratio is almost double its long-term average, suggesting that the stock is well above fundamentals. Unless this number falls below the average, investors should stay away from this stock.