CarMax: A Quality Used Car Dealer Overcoming Obstacles

The company is facing higher interest rates and slower consumer spending

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Sep 16, 2022
Summary
  • CarMax sells used vehicles at over 230 locations across the United States.
  • The company's no-haggle sales model remains popular with consumers.
  • The stock sells near 52-week lows as investors fear a slowdown in consumer spending and higher interest rates.
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CarMax Inc. (

KMX, Financial) is a retailer of used vehicles in the U.S. The company operates through two segments, CarMax Sales Operations and CarMax Auto Finance. It offers purchasing customers a range of makes and models of used vehicles, including domestic, imported and luxury vehicles, as well as hybrid and electric vehicles. It also sells extended protection plans to customers at the time of sale and offers older vehicles that are approximately 10 years old and have more than 100,000 miles through wholesale auctions.

The company also provides reconditioning and vehicle repair services and financing alternatives for retail customers across the credit spectrum through its CarMax Auto Finance and arrangements with various financial institutions.

As of Feb. 28, it operated approximately 230 used car stores. Founded in 1993, CarMax currently has a $13.6 billion market capitalization.

Business model

CarMax traditionally offers a no-haggle pricing system that removes a frequent customer frustration with the purchase process at typical dealerships, allowing customers to shop for vehicles the same way they shop for other consumer products. The company’s omni-channel platform further empowers customers to buy a car on their own terms – either online, in-store or a seamless combination of both. Customers can choose to complete the car-buying experience in person at one of the company’s many stores, or buy the car online and receive delivery through express pickup or home delivery, which is widely available to most customers.

The company reconditions every used vehicle that is sold to meet CarMax Quality Certified standards, and each vehicle must pass a thorough inspection before being offered for sale. The company offers guarantees that give customers the ability to take 24-hour test drives before committing to a purchase as well as provides a 30-day/1,500-mile money-back guarantee as well as 90-day/4,000-mile limited warranty.

Financial review

In June, CarMax reported first-quarter 2023 results for the period ending May 31. Revenue increased 21% to $9.3 billion and the gross profit per retail used unit was $2,339, an increase of $134 versus the prior-year quarter.

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The company sold 427,257 cars, down 5.5% compared to the same quarter a year ago. Total retail used vehicle sales declined 11% to 240,950 and comparable store used unit sales declined 12.7% from the prior-year period. A number of macroeconomic factors weighed on these results, including the lapping of stimulus benefits, widespread inflationary pressures, challenges to vehicle affordability and lower consumer confidence levels.

The company’s finance unit produced income of $204.5 million, which was a decrease of 15.4% from the year-ago period. A large swing in the provision for loan losses was primarily responsible for the decline as CarMax now expects a more normalized environment (meaning more defaults).

CarMax’s balance sheet carries a large amount of non-recourse debt as part of its inventory financing and lending operations. Traditional debt totaled $2.6 billion and unrestricted cash was $95.3 million. The company produced $436.1 million in free cash flow during the quarter.

Valuation

Consensus analyst earnings per share estimates for the fiscal year ending February 2023 are $5.60 and $5.98 for the following year. That puts the company selling at 15 times the current year's earnings. Historical price-earnings ratios for CarMax have often been in the high-teens or low 20’s range.

The GuruFocus discounted cash flow calculator creates a value of approximately $97 using $5.60 as the earnings per share starting point and applying an 8% long-term growth rate.

The company does not currently pay a dividend, but does actively return capital to shareholders through share repurchases.

Guru trades

Gurus who have purchased shares of CarMax recently or added to their positions include

Steven Romick (Trades, Portfolio) and Chuck Akre (Trades, Portfolio)'s Akre Capital Management. Investors who have reduced their positions in the stock include PRIMECAP Management (Trades, Portfolio) and Caxton Associates (Trades, Portfolio).

Conclusion

CarMax appears to be operating successfully despite a difficult inflationary environment. CEO Bill Nash recently said, “CarMax is well positioned to drive profitable market share gains in any environment and compete across the larger used auto ecosystem because of our exceptional associates, unparalleled omni-channel experience, diversified business model, strategic investments, and relentless innovation.”

The stock is selling near 52-week lows and appears to be priced at an attractive entry point.

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Disclosures

I/we have no positions in any stocks mentioned, and have no plans to buy any new positions in the stocks mentioned within the next 72 hours. Click for the complete disclosure
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