Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Carvana Co. (NYSE:CVNA) makes use of debt. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Carvana's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2021 Carvana had US$2.52b of debt, an increase on US$719.3m, over one year. However, it does have US$440.0m in cash offsetting this, leading to net debt of about US$2.08b.
A Look At Carvana's Liabilities
According to the last reported balance sheet, Carvana had liabilities of US$1.33b due within 12 months, and liabilities of US$2.48b due beyond 12 months. Offsetting this, it had US$440.0m in cash and US$194.0m in receivables that were due within 12 months. So it has liabilities totalling US$3.18b more than its cash and near-term receivables, combined.
Of course, Carvana has a titanic market capitalization of US$58.3b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Carvana can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Over 12 months, Carvana reported revenue of US$9.0b, which is a gain of 103%, although it did not report any earnings before interest and tax. So its pretty obvious shareholders are hoping for more growth!
Even though Carvana managed to grow its top line quite deftly, the cold hard truth is that it is losing money on the EBIT line. Indeed, it lost US$82m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through US$2.0b of cash over the last year. So to be blunt we think it is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for Carvana you should be aware of.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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