Investors in online used car superstore Carvana (CVNA 7.34%) are having kind of a terrific day on Friday.
Investment bank RBC Capital Markets just doubled its price target on Carvana shares to $90 per share, and removed its sell rating on the stock, rerating the stock “sector perform.” Markets responded immediately — and Carvana stock is up 13.1% through 10:55 a.m. ET.
RBC removes sell rating on Carvana
Up until today, RBC had insisted that Carvana was uninvestible, and predicted the stock would lose half its value, falling to $45 per share. The problem with that thesis, though, is that too many people agree with it, as explained in a StreetInsider.com write-up today.
Currently, 43% of Carvana’s stock is sold short by traders convinced Carvana stock is doomed. Almost any positive news — for example, a return to more meaningful unit growth or improvements in per car profitability that might permit Carvana to begin paying down debt — could shake that confidence and cause traders to begin covering their short positions. And in that scenario, any rise in Carvana’s share price could quickly snowball, lifting the shares higher, forcing more shorts to close their positions and buy back shares, which would in turn lift the shares higher, forcing more shorts to close their positions and buy back shares — in an infinite loop.
Is Carvana stock a buy?
Given the risk of such a runaway chain reaction, RBC concludes that continuing to short Carvana stock will be “infeasible for the foreseeable future.” The risk of getting caught up in that snowball is just too great.
Admittedly, buying into a stock with $7.4 billion in debt coming due over the next seven years probably sounds pretty risky, too. But with Carvana reporting positive profits again, and expected to generate as much as $4 billion in free cash flow over the next five years, I think the bigger risk today is selling Carvana stock short.
Rich Smith has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
