These ‘zombie’ firms could smell the cash burning, warns New Constructs

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Carvana Co., Freshpet Inc. and Peloton Interactive Inc. could feel cash burn as the Fed raises interest rates, according to independent equity research firm New Constructs.

The research firm, which uses machine learning and natural language processing to analyze company filings and model economic profits, warns that time is running out for companies that are burning cash and staying afloat with easy access to capital.

“As the Fed raises interest rates and ends quantitative easing, access to cheap capital is rapidly drying up,” wrote David Trainer, CEO of New Constructs, in a research note published Thursday. “At the same time, many companies are facing shrinking margins and may be forced to pay no interest without the possibility of refinancing.”

As so-called zombie companies run out of cash to stay afloat, risk premiums will rise in the market, according to New Constructs. This in turn could further reduce liquidity and create a growing series of corporate failures.

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Specifically, Trainer highlights Carvana’s CVNA,
+13.92%
“dwindling cash, intense competition and high valuation”, which put the stock in danger of falling to $0 per share.

“Carvana has failed to generate positive free cash flow in a year since its IPO in 2017,” he added. “Since 2016, Carvana has spent $8.3 billion in FCF (free cash flow).”

Shares of the used-car retailer plunged 88% in 2022 amid downgrades and losses, outpacing the S&P 500’s 20.5% SPX drop. In April, Carvana reported bigger-than-expected losses in the first quarter, citing a “particularly difficult environment”. Last month, Carvana also announced plans to lay off more than a tenth of its staff.

Like GameStop Corp. meme stocks. EMG,
+2.57%
and AMC Entertainment Holdings Inc. AMC,
-4.37%
Carvana is strongly shorted. New Constructs placed Carvana in the research firm’s “danger zone” in August 2020 and Trainer notes that in short, it has outperformed the S&P 500 by 95% since then. However, even with its year-to-date declines, Trainer believes the stock has more downsides.

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Another zombie company is pet food manufacturer Freshpet FRPT,
+8.62%,
according to the CEO of New Constructs. “Freshpet shares surged during the pandemic as investors shrugged off the company’s years of cash burn, and now investors are finally waking up to the dangers inherent in Freshpet shares, which could plummet to $0. per share,” he wrote. “Freshpet increased revenue at the expense of bottom line, and sales growth resulted in greater cash burn.”

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Freshpet stock has fallen 41% in 2022 and over the past 12 months its shares have fallen 65.5%, compared to the 10.1% decline in the S&P 500 over the same period. The company recently released fiscal forecasts for the fourth quarter and full year that were lower than analysts’ expectations.

The coach also has a negative view of Peloton’s PTON,
+7.57%
Stock. “Peloton’s problems are well telegraphed – given the stock’s decline over the past year – but investors may not realize that the company has only a few months of cash left to fund. its operations, which puts the stock in danger of falling to $0 per share,” he wrote.

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“Despite rapid revenue growth, particularly in 2020 and 2021, Peloton’s free cash flow (FCF) has been negative every year since fiscal 2019.” Since then, Peloton has spent $3.7 billion, he added.

Trainer also pointed to Peloton’s recent five-year, $750 million loan from JP Morgan Chase & Co. and Goldman Sachs, which he described as “extremely” creditor-friendly. “If we assume the average consumption of FCF over the past two years and include the additional capital raised a month ago, Peloton has only 11 months of cash left before it needs to raise more capital or cease operations” , he wrote.

Last month, Peloton presented an optimistic outlook when it reported its fiscal third quarter results, citing “weaker demand”. Shares of the company have fallen 71.53 this year and 91.3% in the past 12 months.

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