CarMax (KMX, Financial) is the largest used car retailer in the United States and has been one of the bright spots in the retail sector over the past few years. CarMax's business model is simple: it buys and sells used cars and offers to finance customers who want to purchase a vehicle.
However, as interest rates rise, CarMax's top-line growth could be under pressure in the coming quarters. With higher interest rates, CarMax's financing costs will increase, adding to the stress of inflation causing higher sticker prices. As a result, CarMax's growth could slow down as consumers are priced out of the market. It will need to find a way to offset this headwind to maintain its strong performance.
The company has been able to thrive in recent years by offering low prices on high-quality used cars. However, another problem has arisen from higher competition, as other used car dealerships are starting to offer similar prices. To stay ahead of the inflationary trend, CarMax will need to find a way to either increase its prices or reduce its costs. Otherwise, the company risks being pushed out of the market by its more nimble competitors.
CarMax is facing the heat
The pandemic hit in 2020, and as a result, most auto manufacturing companies produced fewer cars due to labor shortages. This provided CarMax with an opportunity - it profited from the increased demand for used vehicles because of this situation. However, things are changing.
CarMax is now feeling the squeeze as high used car prices and rising loan rates substantially affect consumer purchasing power, which in turn decreases the company's bottom line. The company has seen its profits shrink as fewer consumers buy cars, and those purchasing are opting for cheaper, lower-quality cars. CarMax has responded by closing some of its stores and cutting costs, but it remains to be seen if these measures will be enough to offset the challenges it faces. In the meantime, CarMax will continue to feel the squeeze, and unfortunately for the company, downturns in the automotive market tend to be steep.
CarMax earned $8.14 billion in net revenue for the second quarter of 2022, an increase of 2% from the same period a year ago. Earnings per share for the second quarter, however, dropped by 54% to 79 cents from $1.72 in the prior-year quarter. The total wholesale unit sales declined by 15.1%.
The market is not doing too well, and here we see the numbers to back that up. Retail and wholesale combined unit sales decreased by 10.3% year-over-year to 376,616 units, and we're seeing lower used sales numbers in retail stores and the total market, with respective year-over-year drops of 6.4% and 8.3%.
The per unit gross profit also was down by $124 to $881. One of the factors was the lower quality vehicles received by the company, which CarMax sold in bulk with reduced margins.
Stephens and Morgan Stanley (MS, Financial) issued pessimistic views on the stock after earnings failed to impress the markets. Stephens assigned a price target of $64, downgrading shares from Equal Weight to Overweight. The financial services firm expressed concerns about CarMax's potential with decreasing demand for used vehicles. Morgan Stanley, meanwhile, sounded the alarm about demand destruction and its impact on CarMax moving forward.
Nimbler competitors are emerging
Increasing competiton is also impacting CarMax. For example, Carvana (CVNA, Financial) is an online used car retailer that is shaking up the industry. It offers a 100-day warranty, free home delivery and a seven-day trial. CarMax cannot match these offerings. In addition, Carvana has an expansive inventory of vehicles CarMax cannot keep up with. Carvana is also cheaper than CarMax because the latter has physical locations and overhead costs to contend with. Carvana is a clear threat to CarMax and is quickly gaining market share.
In response, CarMax is investing heavily in developing its Omnichannel, a platform that combines its online and offline store offerings. CarMax clients can search for vehicles online and order them. They can schedule deliveries at a dealership and even have cars sent from nearby or distant dealerships to one nearby. The company also facilitates its customers by allowing them to complete many purchases online, making it an easy process for everyone. The new customer relationship management platform can be a game changer for CarMax by providing it with data to use in meaningful ways. It should also help the company generate more sales over time. However, at this time, I believe Carvana has a clear advantage.
Takeaway
In the past couple of years, CarMax has been a beneficiary of easy credit, as many customers finance their purchases through CarMax's in-house financing arm, as well as higher used car prices as automakers were under pressure from supply shortages. However, with interest rates rising and consumers beginning to feel the squeeze of higher prices, CarMax's stock may not be as immune to a slowdown as it has been in the past. As a result, investors should tread carefully with CarMax stock for now.
