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These ‘zombie’ companies could feel the cash burn, warns New Constructs

Carvana Co., Freshpet Inc. and Peloton Interactive Inc. could feel the 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 parse corporate filings and model economic earnings, warns that time is running out for cash-burning companies kept afloat with easy access to capital.

“As the Fed raises interest rates and ends quantitative easing, access to cheap capital is drying up quickly,” writes New Constructs CEO David Trainer, in a research note released Thursday. “At the same time, many companies face declining margins and may be forced to default on interest payments without the possibility of refinancing.”

As so-called zombie companies run out of the cash needed to stay afloat, risk premiums will rise across the market, according to New Constructs. This, in turn could further squeeze liquidity and create an escalating series of corporate defaults.

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Specifically, Trainer highlights Carvana’s

“dwindling cash supply, intense competition and elevated valuation,” which put the stock in danger of declining to $0 a share.

“Carvana has failed to generate positive free cash flow in any year since going public in 2017,” he added. “Since 2016, Carvana has burned through $8.3 billion in FCF (free cash flow).”

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

Like meme stocks GameStop Corp.

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Carvana is heavily shorted. New Constructs put Carvana in the research firm’s “danger zone” in August 2020 and Trainer notes that, as a short, it has outperformed the S&P 500 by 95% since then. However, even with its year-to-date declines, Trainer thinks the stock has more downside.

Another zombie company is pet food maker Freshpet
according to the New Constructs CEO. “Freshpet’s stock surged during the pandemic, as investors ignored the company’s years of cash burn, and now, investors are finally waking up to the dangers embedded in Freshpet’s stock, which could decline to $0 per share,” he wrote. “Freshpet has grown the top line at the expense of the bottom-line, and sales growth has driven more cash burn.”

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Freshpet’s stock has fallen 41% in 2022 and over the last 12 months, its shares have tumbled 65.5%, compared to the S&P 500’s 10.1% decline over the same period. The company recently gave fiscal fourth-quarter and full-year guidance that were below analyst expectations.

Trainer also has a negative opinion of Peloton’s

stock. “Peloton’s issues are well telegraphed – given the stock’s decline over the past year – but investors may not realize that the company only has a few months’ worth of cash remaining to fund its operations, which puts the stock in danger of falling to $0 per share,” he wrote.

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

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

Last month Peloton delivered a downbeat outlook when it reported its fiscal third-quarter results, citing “softer demand.” The company’s shares have fallen 71.53 this year and 91.3% in the last 12 months.

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