Carvana Co. credit rating upgraded at S&P due to improved performance

Investing.com -- S&P Global Ratings has upgraded the credit rating of U.S.-based Carvana Co (NYSE:CVNA). to ’B’ from ’B-’ due to ongoing improvements in performance and stronger credit metrics. The company’s senior secured debt rating has also been upgraded to ’B’ from ’B-’, and its senior unsecured debt to ’CCC+’ from ’ CCC (WA:CCCP)’. The positive outlook indicates that Carvana could receive another upgrade within the next 12 months if it continues to improve its operating performance while maintaining a leverage below 5x and free operating cash flow (FOCF) to debt above 5%.

Carvana’s business growth, stronger EBITDA margins, and improved credit metrics have contributed to the upgrade. The company’s EBITDA margins grew to 10.6% in fiscal 2024, up from 3.9% in 2023, and sales reached $13.7 billion in 2024, up from $10.8 billion in 2023. Carvana has also increased its retail gross profit per unit (GPU) to $3,312, up from $2,385 in 2023, while expanding unit sales volume by 33.1%. These improvements, along with some gross debt paydown, resulted in leverage improving to about 5x in 2024 from about 17.8x in 2023.

Carvana’s revenue growth is forecasted to be about 14.9% in 2025, primarily due to an increase in unit sales. This growth will be supported by the opening of 10 to 12 ADESA mega sites in 2025 to expand its inventory offering and reconditioning capacity. However, EBITDA margins are expected to slightly contract to 10.5% in 2025 from 10.6% in 2024 due to a small drop in GPUs, somewhat offset by improved overhead expense leveraging.

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The company is expected to maintain disciplined cost control even as it continues to scale units sold and grow revenue. Carvana currently has unused lots, equipment, and reconditioning capacity on its ADESA sites. Fully integrating all 56 ADESA mega sites could enable the company to expand its current volumes by 8x. To bring the planned remaining 8-10 sites online this year, it will step up its capital expenditure (capex) investment year over year. Given its current EBITDA generation, the company will be able to more than sufficiently fund this expansion and make its mandatory cash interest payments while also maintaining strong FOCF generation.

Key risks for Carvana include its ability to maintain a strong inventory turn and control SG&A spending as unit sales increase. The company has managed SG&A well over the past few years, but historically when it expanded too aggressively, SG&A also expanded too quickly. Furthermore, Carvana must maintain high standards in its reconditioning process even as unit growth expands by keeping returns consistent with historical levels.

Carvana’s other GPU has been improving, reaching $2,771 compared with $1,945 last year. However, further diversification of loan sale channels would enhance its risk profile. The company added another third-party loan buyer in the second quarter of 2024, creating an additional channel for loan sales alongside asset-backed securities (ABS) and the Ally Master Purchase and Sale Agreement.

Further ratings upside will depend on Carvana’s continued deleveraging path and financial policy. While leverage is forecasted to drop below 5x and FOCF to debt to exceed 5% in 2025, S&P Global Ratings prefers to see a consistent track record of maintaining these metrics before considering an upgrade. Additionally, Carvana has a $1 billion at-the-market facility to raise additional equity, after raising $1.3 billion through its prior at-the-market facility in 2024. The company redeemed $470 million of principal amount of the 2028 senior secured notes in 2024.

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S&P Global Ratings could revise its outlook back to stable if it expects the company to manage leverage above 5x and FOCF to debt below 5% over the longer term. This could happen if operating performance deteriorates such that margins decline materially, or if the company adopts a more aggressive financial policy and issues debt to fund acquisitions, growth initiatives, or shareholder returns.

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