Through this article I am going to compare and contrast the business of America’s Car-Mart against the ideas brought forth in the books "The Warren Buffet Way" and "The Outliers: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success."
Is the Business Simple and Understandable?
America’s Car-Mart (CRMT) is one of the largest “Buy Here, Pay Here” auto dealerships in the U.S. It operates 130 dealerships in the Southcentral United States including Arkansas, Oklahoma, Missouri, Texas, Kentucky, Alabama, Mississippi, Tennessee, Georgia and Indiana. They are in the business of selling older model used vehicles and provide financing to customers that have impaired credit and limited financial resources. Once the sale is finalized, payments are scheduled to coincide with the customer’s pay date, usually on a weekly, bi-weekly, bi-monthly or monthly basis. Payments are often, but not always, made in person.
From the 10-K: “The primary drivers of operating profits and cash flows include (i) top line sales (ii) interest rates on finance receivables, (iii) gross margin percentages on vehicle sales, and (iv) credit losses, a significant portion of which relates to the collection of principal on finance receivables.”
In essence, this is a finance company based on customer relationships that happens to deal in the used car market. It’s not as complicated as microprocessors, though not as simple as chewing gum – but the answer is “YES.”
Does the Company Have a Consistent Operating History?
Although past performance is no guarantee of future results, it does show whether a business can operate in a variety of business conditions. It is important to remember the company just weathered “The Great Recession.”
Again from the 10-K: “Car-Mart has been operating since 1981. Car-Mart has grown its revenues between approximately 3% and 16% per year over the last ten years (average 12%). Growth results from same dealership revenue growth and the addition of new dealerships. Revenue increased 8.0% for the fiscal year ended April 30, 2013 compared to fiscal 2012 primarily due to an 8.0% increase in retail units sold, a 0.5% increase in average retail sales price and a 13.0% increase in interest income.”
It hasn’t been around as long as Coca-Cola, but again the answer is “YES.”
Does the Business Have Favorable Long-Term Prospects?
Buffett believes in holding good companies for the long term and that means seeing a clear future. Companies that operate on trends, fads and technology that is out of date tomorrow don’t fit this model regardless of how profitable they are in the short run.
CRMT operates in communities with populations of 20,000 to 50,000. However, it has also been successful in larger communities. Given the need for basic transportation in our economy, CRMT is wise to operate in communities with limited to no public transportation systems in place. It also has plans to grow the company dealership count by 10% per year into the foreseeable future. New dealerships can be cash flow positive within the first year and typically grow sales by 10% per year for the next several years. Below is a picture of their projected operations, with current dealerships in red and potential locations in blue. “YES” indeed, this company has a bright future.
Is the Management Rational?
Buffett places a great deal of importance on management and one of the areas he focuses on is how excess cash is used. If the company can generate above average returns by reinvesting the cash in the business it should do so because this builds shareholder value. However, if not, the management should return the cash to shareholders. In other words, the decision should be rational.
By looking at the chart below it’s evident that management believed in past years the stock was significantly undervalued and made the decision to allocate capital to stock buybacks.
Management has shown themselves to be adept at growing the business and rewarding shareholders with stock buybacks – whichever will give a better rate of return. The answer to our question is “YES.”
Is the Management Candid with Shareholders?
Buffett believes that many company executives still hide behind accounting conventions and don’t fully report to shareholders. He admires managers that admit mistakes and take responsibility for the company.
CRMT executives have been very forthright in highlighting the risks to the company. These risks include higher delinquency rates, higher borrowing costs, competition when purchasing vehicles and increased regulation. Delinquency rates have been creeping up in recent years. Due to competitive pressures, CRMT has had to decrease the down payment and lengthen the average term of the loan. Increased competition for sub-prime loans is arising from capital markets reaching for yield. As down payments decrease and term lengths increase, consumers have less equity in the vehicle. The average length of each loan has subsequently increased from 26.8 months as of April 30, 2012 to 29.5 months in the most recent quarter. The average delinquency occurs at 10.5 months into the term of the loan. This is not a trend that CRMT wants to see continue.
The average price of vehicles sold is also creeping up as used car prices are still elevated due to fewer new cars being sold during “The Great Recession.” This has caused a decreased available inventory from which to choose. CRMT has been passing the increased cost on to the consumer, causing the average purchase price to increase.
Years ending April 30
2013 2012 2011
Retail units sold 40,737 37,722 34,424
Average dealerships in operation 118 110 101
Average units sold per dealership 345 343 341
Average retail sales price $9,721 $9,675 $9,361
The challenge for the company is keeping payments affordable so customers can make timely payments and develop equity quickly – making them less likely to walk away from the vehicle and the loan. CRMT is not a company that can charge a premium for their service. The company must instead focus on being the low cost producer of two commodity services – finance and used car sales.
The company currently operates under a revolving credit facility that is equal to LIBOR plus 2.5%. At most recent quarter, CRMT had an approximate balance of $100 million of an available $145 million. Therefore, a 1% increase in the cost of borrowing would decrease earnings before taxes by approximately $1 million, or 3.5% of trailing 12 month after-tax earnings.
Sub-prime lending is increasingly under scrutiny recently. The recently established Consumer Finance Protection Bureau could propose regulations making it more difficult for CRMT to serve its customers.
All of the above risks and challenges have been outlined in the yearly reports, quarterly reports, and investor presentations on the company website. Therefore, one can conclude that, “YES,” management is candid with shareholders.
Does Management Resist the Institutional Imperative?
Call this peer pressure for CEO’s, or the need to fatten one’s wallet at the expense of shareholders. You could also look at it as the need for management to make recent quarters look good to avoid short term pain at the expense of long term profits.
Stock based compensation for the six months prior to the most recent reporting period was 6.7% of net income. This compares to 7.7% of net income during the same reporting period in the previous year. How does this compare to other companies? CarMax (CMX) had share based compensation expense in the previous nine months of the most recent reporting period at 14% of net income, and 14.2% during the same nine months of the previous year. CRMT also compares favorably with Wells Fargo (WFC), who had stock-based compensation expense of 9.3% of net income in the previous nine months prior to their most recent 10-Q, and 9.3% for the same period one year ago. Wells Fargo is Warren Buffett (Trades, Portfolio)’s favorite low cost finance provider, and CRMT executives show they now how to be just as frugal.
CRMT is a very conservatively run company that doesn’t try to polish its financial statements in the hopes that investors will cheer a good quarter. For the six month ending Oct. 31, 2013, provisions for credit losses were a whopping 26.25% of sales, compared to 20.75% for the full year of 2011. This is management’s way of handling the risks and challenges we discussed above, but may also be a source of unlocked value for investors if reversion to the mean is to occur.
I believe CRMT to be a very well-run company with competent and capable management. Again, the answer to the above question is “YES.”
What Is the Average Return on Equity?
Buffett focuses on return on equity rather than the more popular earnings metric in evaluating companies. His rationale is that earnings are fleeting and can be manipulated. Long term, return on equity will have a more profound effect on the company’s fortune than earnings.
The average return on equity for CRMT over the last 5 years is 15.1% compared to 11.4% for WFC.
What Are the “Owner Earnings”?
Future “owner earnings” for this company are going to hinge on the company’s ability to keep provision for credit losses in check, as it believes it will be able to maintain its operating margin at or near 42%. If the company succeeds, owner earnings should grow consistently with revenue from sales.
What Are the Profit Margins?
If a company can’t convert sales into profits, it has obviously failed. One of the ways this happens is to keep expenses to a minimum. Buffett avoids companies with bloated expenses because it reflects a lack of discipline even if the company is profitable – it would be more profitable if expenses were always controlled.
As you can see, CRMT is a consistent performer. The culling of unnecessary expenses is a virtue that drives CRMT’s performance. Stable and consistent margins are the signs of a company with stable operating advantages.
What Is the Intrinsic Value of America’s Car-Mart?
CRMT has been able to grow book value per share from $7.30 in April 2004 to $22.41 in April 2013. That equates to a compound annual growth rate of 13.26%. Using a more conservative growth rate of 12% over the next 10 years and a conservative discount rate of approximately 2x the 10-year note, we arrive at an intrinsic value of $44.59 (source: buffetsbooks.com).
We currently find CRMT at a 52-week low on 02-05-2014 and trading at $36.84, giving a 17.4% margin of safety. With a current PE of 11.61 the earnings yield on CRMT is 8.61%.
Use of Decentralized Operations as a Business Advantage
One of the common themes in the aforementioned book, “"The Outliers: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success," is the use of decentralized operations. This allows for less overhead and greater efficiencies throughout the organization. The following is an excerpt from CRMT’s most recent 10-K:
“Maintaining a Decentralized Operation. The Company’s dealerships will continue to operate on a decentralized basis. Each dealership is ultimately responsible for buying (via an assigned corporate office purchasing agent) and selling its own vehicles, making credit decisions and collecting the contracts it originates in accordance with established policies and procedures. Most customers make their payments in person at one of the Company’s dealerships. This decentralized structure is complemented by the oversight and involvement of corporate office management and the maintenance of centralized financial controls, including monitoring proprietary credit scoring, establishing standards for down-payments and contract terms as well as an internal compliance function.
Cultivating Customer Relationships. The Company believes that developing and maintaining a relationship with its customers is critical to the success of the Company. A large percentage of sales at mature dealerships are made to repeat customers, and the Company estimates an additional 10% to 15% of sales result from customer referrals. By developing a personal relationship with its customers, the Company believes it is in a better position to assist a customer, and the customer is more likely to cooperate with the Company should the customer experience financial difficulty during the term of his or her installment contract with the Company. The Company is able to cultivate these relationships as the majority of its customers make their payments in person at one of the Company’s dealerships on a weekly or bi-weekly basis.”
CRMT has over 1,200 employees, but only a small fraction of them are located at corporate headquarters in Bentonville, Ark. The majority are out interacting with their customers, actively involved in their community. Meanwhile, management has their finger on the pulse of the company, actively monitoring the daily, weekly and monthly dealership reports.
Dealership managers and associates are responsible for collecting/receiving payments from customers. Their salary is dependent, in some part, on customers making timely payments. This creates a nice alignment of incentives from the customer all the way up to the shareholder. When the customer succeeds, everybody in the organization wins.
CRMT is a simple, predictable performer with a long history of success. It is run by able and competent management and has displayed stable profit margins and above-average returns on equity. It is currently trading at a discount to fair value and has a structural organization that favors long term success.
"Heads I win. Tails I don't lose much." — Mohnish Pabrai
(Disclaimer: author is long CRMT and plans to purchase more shares on future price weakness.)