Shares of Carvana continue to surge as the online seller of used cars delivers impressive earnings results. Starting the year at under $5, the stock now sits at over $55, leaving investors curious about what lies ahead for the company.

Closing 40% higher at $55.80 on Wednesday, Carvana (CVNA) stands out amid the S&P 500 and Nasdaq Composite, which saw only marginal gains.

One key piece of the puzzle is Carvana's improved financial outlook. In the second quarter, the company reported a per-share loss of approximately $1.11, surpassing Wall Street's predicted loss of $1.13. Earnings before interest, taxes, depreciation, and amortization also exceeded expectations by a significant margin.

On June 8, Carvana revealed its projected EBITDA for Q2 to be more than $50 million. However, the actual figure came in at $155 million, or $85 million net of $70 million in nonrecurring benefits. According to Gordon Haskett analyst Don Bilson, this outcome is noteworthy given initial expectations.

Additionally, Carvana announced that it has reached an agreement with its lenders to eliminate a major portion of its debt due in 2025 and 2027. While this grants the company increased financial flexibility, it is essential to note that Carvana is still operating at a loss and the long-term forecast remains relatively unchanged.

Sales outlook for 2024 currently stands at $11.9 billion, down from the previously projected $13.1 billion as a result of declining used-car prices across the market. Analysts anticipate that Carvana will also sell fewer vehicles, with projected sales of approximately 377,000 cars and trucks in 2024 compared to the previous estimate of around 420,000.

Although reduced sales volume indicates smaller losses, the expected loss per share for 2024 is now $4.87, down from the previous estimate of $5.37. However, the company is still experiencing significant cash outflow, with an expected negative free cash flow of $667 million in 2024, compared to the previously projected negative $642 million.

The Real Reason Behind Carvana's Stock Surge

Carvana, a widely known online used car retailer, has experienced a remarkable stock-price gain of over 1,000%. While many may attribute this surge to various factors, such as strong performance or positive market trends, the truth lies elsewhere. The principal driver behind this extraordinary growth is actually fear of losses faced by short sellers.

According to Ihor Dusaniwsky, managing director at S3 Partners, a leading publisher of short-selling research and statistics, an astounding 47.8% of Carvana's available shares have been sold short. This amounts to a staggering 40.4 million shares, equivalent to $1.6 billion in value. Such a high short interest is unprecedented for a company of Carvana's size.

For comparison, the average percentage of shares sold short for an S&P 500 company is less than 2%. When any positive developments occur with heavily shorted stocks, investors become eager to close out their bearish bets, resulting in substantial price surges. In fact, Dusaniwsky reveals that there has been a significant short covering of 13.75 million shares in 2023, worth $547 million. Consequently, short sellers targeting Carvana have suffered significant losses, with $1.54 billion in year-to-date mark-to-market losses in 2023 and an additional $442 million lost in July alone.

Despite the remarkable upward movement, Carvana's stock remains down approximately 86% from its record highs of around $377 established in 2021. While there is potential for further growth, the valuation does not seem warranted.

Leading market experts anticipate that Carvana will generate roughly $250 million in positive free cash flow by 2026. As a result, the stock is currently trading at approximately 31 times that amount. In contrast, the S&P 500 trades at around 22 times the estimated 2024 free cash flow.

Although some individuals may remain optimistic about Carvana's future prospects, skepticism persists. The eventual completion of short sellers covering their positions will reduce buying pressure, potentially dampening the rally. Additionally, the overall financial outlook for Carvana remains less than promising. Nevertheless, it is worth noting that Carvana has the potential to surpass cash generation expectations sooner than projected.

Given the uncertainties surrounding Carvana's stock surge, investors are advised to approach the situation with caution.

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