David Trainer, CEO of research firm New Constructs, had been telling anyone who will listen that many tech stocks are trading at bubble levels, without the fundamentals to support their valuations. Even worse, some are zombie companies, that cannot generate the cash flow to support their debts, so they just keep borrowing to stay alive. One of the most prominent zombies he identifies is the exercise company Peloton.
Trainer’s company uses cutting edge machine learning to analyze markets, and has partnerships with many hedge funds and information providers, including Refinitiv and Ernst & Young.
Trainer says that as the Fed tightens monetary policy and raises interest rates, he expects the value of many of these zombie companies to drop to zero as the cost of borrowing rises.
Trainer wrote in a research note, “Time is running out for cash-burning companies kept afloat with easy access to capital. These ‘zombie’ companies are at risk of going bankrupt if they cannot raise more debt or equity, which is not as easy as it used to be. As the Fed raises interest rates and ends quantitative easing, access to cheap capital is drying up quickly.”
Three zombie companies he identified are Peloton, Carvana, and Freshpet.
Peloton gained adherents during the pandemic when everyone was locked at home or working from home and investors rushed to find companies which would benefit from that.
During that time Peloton surged from $20 per share to $162 per share. But regardless, Trainer wasn’t sold. He had added Peloton to his “Danger Zone” list in September of 2019, a list of stocks whose underlying fundamentals had problems and didn’t match their valuations. He made the case Peloton was burning through cash at an unsustainable rate.
Peloton has since dropped to $10 per share, and Trainer says it will get worse from here. He wrote, “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.”
Trainer’s New Constructs team has noted that every year since 2019, Peloton has had negative free cashflow, meaning after it pays operating expenses, and capital expenditures, it has only accrued more debt. As of now, the company has blown away $3.7 billion in free cash flow and will have to raise more money if it hopes to continue to operate at its current spending rate.
Carvana was another stock which investors flocked to in the pandemic. when used car prices soared due to the supply chain issues that came from lockdowns and shipping disruptions, Carvana stock surged from under $30 per share to over $360 in August of 2021.
Trainer and his team had put Carvana in his “Danger Zone” list in August of 2020, and so far it has collapsed more than 88% just this year. Now Trainer even says the company may go bankrupt, with its stock falling to $0.
Carvana has never generated free cash flow, going back to when it first went public, in 2017. SO far it has burned through $8.6 billion since that time. IN April it was forced to take on $3.3 billion in unsecured loans, at an interest rate of 10.25%. Even so, Carvana will be forced to raise cash again at the end of the year.
Trainer wrote, “Carvana’s dwindling cash supply, intense competition, and elevated valuation puts the stock in danger of declining to $0 per share, which would be devastating for investors, especially those who purchased the stock in summer 2021, when it traded north of $300 per share.”
The third stock Trainer highlighted was Freshpet. Trainer notes that although Freshpet was another pandemic darling, investors didn’t pay attention to its shaky business model and the company’s history of burning through cash.
Trainer’s team put Freshpet in the “Danger Zone” in February of 2022, noting it spent tremendous amounts on advertising to increase revenue growth, but had never shown that it could turn a profit.
Since then the stock is down more that 40%, and according to Trainer at its current burn rate, it has only nine months of cash before it will need to take on more debt.
Trainer wrote, “Investors are finally waking up to the dangers embedded in Freshpet’s stock, which could decline to $0 per share. Freshpet has grown the top line at the expense of the bottom-line, and sales growth has driven more cash burn. The firm’s free cash flow (FCF) has been negative every year since 2017, and its FCF burn has worsened in recent years.”
