1) Last week, used-car seller Carvana (CVNA) reported a self-proclaimed "outstanding" quarter (press release here and shareholder letter here)...
Revenue jumped 52%, which does appear outstanding at first glance. But dig a little deeper and the story quickly becomes murkier... Diluted earnings per share only rose 11.9% thanks to declining margins, and operating cash flow declined as 54%, as I discuss below.
I added Carvana to my "Stinky Six" list of stocks to avoid on December 12. Since then, it's down 15% versus an 8% gain for the S&P 500 Index.
Yesterday, I quoted my hedge-fund manager friend about his largest long position, Willis Lease Financial (WLFC). Carvana is his fund's largest short position, so I reached out to him again for his thoughts. He wrote:
The numbers look good on the surface, but picking them apart leaves a lot of questions. The gross profit per unit bounced back from last quarter but is still down over the recent run rate, and we continue to believe that related party transactions are inflating the numbers.
This economic environment with high oil prices and inflation is simply bad for its business, and we think the market is ignoring the fact that this is a highly competitive business where Amazon (AMZN), CarMax (KMX), and others are increasing their competitive pressure.
Lastly, the trivial questions from outrageously bullish sell-side analysts on the conference call prove that they are missing the biggest risk with this company, which is the subprime credit dynamic.
If the stock traded down 50% tomorrow, it would still be very difficult to justify the valuation.
I sent him these charts from Charlie Bilello and asked if he thought the data points are bearish for Carvana:
He replied that they're very bearish, because:
If someone's car is getting old and they want to upgrade, CVNA can win by making money on the trade-in and the sale of their next car and the financing. But with people so far underwater, the math doesn't work. Instead of three profitable transactions for CVNA, for many customers it's now zero. Further, CVNA still has credit risk on the books for loans it made to all these folks who are now severely underwater.
My friend Chris Irons, who posts on Substack under the handle Quoth the Raven, had a similar take (only paid subscribers can see the full post):
... buried beneath the celebratory headlines is a glaring omission: there has been virtually no serious, in depth discussion about what is actually driving these numbers. Once again, Carvana appears to be generating "incredible" results in part by selling loans to opaque buyers who, at least on the surface, seem willing to pay prices that defy typical market logic...
The issue of who Carvana is selling its loans to is hardly new. Last year, Gotham City Research alleged that Carvana overstated its 2023 and 2024 earnings by more than $1 billion. Central to that claim is the role of DriveTime Automotive Group, controlled by Ernest Garcia II, the father of CEO Ernie Garcia III.
Chris concluded:
... the apparent strength in Carvana's numbers may be less a function of operational excellence and more a product of a tightly controlled financial ecosystem where risk is shifted, profits are manufactured, and transparency is limited.
When viewed through that lens, the recent earnings beat raises more questions than it answers. It forces investors to ask whether the performance being celebrated is sustainable – or even real in an economic sense – once the effects of related-party support are fully understood.
I'll add one more warning flag: When a company grows its revenue 52%, yet its operating cash flow drops by 54%... that's cause for concern. This is especially true of a company that's making loans and selling them.
Take a look at the top third of Carvana's cash-flow statement – I've highlighted the numbers that jump out at me:
Look at how massive the numbers are for originations and sales of finance receivables – more than 10 times net income last quarter. That tells me this is primarily a risky financial company, not a retailer.
As you can also see above, cash consumed by gains on loan sales rose by $81 million. Accounts payable and accrued liabilities generated $163 million in cash – but this could be a warning flag that the company is taking longer to pay its bills. Lastly, as noted earlier, operating cash flow crashed by 54%, from $232 million to $107 million.
In summary, I don't like this cash-flow statement one bit – another reason why Carvana remains firmly on my Stinky Six list.
2) On April 17, I wrote about the epic short squeeze of car-rental company Avis Budget's (CAR) stock. And I concluded: "I would guess that we're very close to the top and that Avis' stock [which closed that day at $493.86] will soon be back to around $100 per share."
Sure enough, the company reported dismal earnings on April 29, the short squeeze ended, and the stock has crashed by 67% in less than three weeks!
This Wall Street Journal article has another interesting twist in the saga regarding the trading of one of Avis' largest shareholders, hedge fund Pentwater Capital Management:
[Avis CEO Brian] Choi indicated Pentwater might not be able to keep all of the gains from its recent trades, thanks to a niche trading rule that prevents company insiders and major shareholders such as Pentwater from buying and selling shares within a six-month period. Known as the short-swing profit rule, the provision can require such insiders to hand over any resulting profits to the company.
Don't cry for Pentwater, however:
The money might ultimately amount to a small slice of Pentwater's overall windfall. Pentwater said in regulatory filings that 94,000 of the 4.3 million shares it unloaded last week as the stock plummeted are subject to the short-term profit rule. The firm said it is engaged in discussions with Avis and has voluntarily agreed to hand over any profits from those 94,000 shares.
I stand by my $100 price target, so I would continue to avoid this stock.
3) I've written many times recently about the struggles of ChatGPT maker OpenAI. This WSJ article is further evidence that the company is in trouble:
OpenAI Chief Executive Sam Altman discussed spinning out the company's robotics and consumer-hardware divisions late last year, a move intended to give them more room to grow without weighing down the core business.
As part of the plan, the two companies would have been able to raise external funding and operate more independently. But it was rejected, in part because OpenAI concluded the new entities might have to remain consolidated on its balance sheet, according to people familiar with the matter.
I've said before that OpenAI could very likely be this year's WeWork. So, which stocks might be impacted if I'm right?
This chart from the Information, sent to me by a friend, provides a starting point for that analysis. It shows the spending commitments of OpenAI and Anthropic, which owns rival chatbot Claude, to the four biggest U.S. cloud providers:
It's good to see that one of my favorite companies, Google parent Alphabet (GOOGL), has no exposure to OpenAI. And I'm not worried about Amazon, which remains my top pick this year among the big tech stocks.
Microsoft's (MSFT) backlog is more exposed to OpenAI, and it owns 27% of the privately held company. But I'm not concerned because Microsoft's revenue and profit streams are so diverse. Plus, its stock is down 23% from its October peak and only trades at a modest 25.2 times this year's earnings estimates.
Oracle (ORCL) is the stock I'd avoid here. It has the most exposure to OpenAI, has taken on huge amounts of debt ($162 billion, offset by only $38 billion in cash), and its stock, while down more than 40% from its highs last fall, still trades at 26.7 times this year's estimates.
Best regards,
Whitney
P.S. I welcome your feedback – send me an e-mail by clicking here.