CarMax - Great Results And Even Better Track Record Come At A Too Steep Price

Jun.22.14 | About: CarMax Group (KMX)

Summary

CarMax reported very strong first quarter results, triggering a huge rally in its stock.

The largest US company re-selling used cars has an excellent long term profitable growth track record.

Appeal is limited at premium multiples for a company still influenced by market cycles.

CarMax (KMX) reported a stellar set of results on the final trading day of the week. Double-digit topline revenue growth and very strong earnings numbers came unexpected propelling shares to fresh all time highs.

While I applaud management for having a great quarter, the valuation has risen too much for me to consider jumping the bandwagon despite the excellent results and stellar track record.

First Quarter Highlights

CarMax reported first quarter revenues of $3.75 billion, up 13.3% compared to a year earlier. Revenues came in far ahead of consensus estimates at $3.60 billion.

Reported earnings were up by 15.7% to $169.7 million. Thanks to modest share repurchases earnings per share grew even quicker. On a diluted basis, earnings rose by 18.8% to $0.76 per share. Analysts were expecting earnings to rise by just three cents to $0.67 per share.

Looking Into The Strong Quarter

Reported revenue growth came on top of the very strong results reported already a year earlier. Growth was driven by strong traffic overall, despite harsh weather at the start of the quarter. Comparable sales rose by 6.6% in terms of revenues and by 3.4% in terms of units. The major source of growth continues to be the aggressive pace of store openings, with CarMax opening 3 super stores during the quarter.

As such used vehicle sales were up by 13.3% to $3.06 billion. The company sold 150,528 used vehicles which was 9.8% more than last year as average selling prices rose by 3.2% to $20,173 per car. New vehicle sales rose by 33.1% to $69.8 million as units rose by 33.2% to 2,597 with average selling prices being virtually unchanged at $26,761.

Wholesale units were up by 9.9% to 97,098 as well thanks to higher traffic and the opening of new stores. Wholesale revenues improved by 11.1% to $545.2 million as average selling prices improved by 1.2% to $5,450. All other sales were up by 13.0% to $74.8 million.

Gross earnings compressed by about 10 basis points to 13.4% of sales. Auto Finance income was down by 10 basis points as well to 2.5% of sales. The solid topline growth allowed CarMax to lever its selling, general and administrative expenses which fell by 40 basis points to 8.4% of sales, allowing net margins to improve by 10 basis points to 4.5% of sales.

Investor Presentation

Back in April, CarMax held its investor meeting stressing its competitive advantages. CarMax offers low but no-haggle prices, a huge selection, guaranteed quality, all being delivered through a friendly sales process.

The strong employee culture and adoption to changing market conditions makes the company with a 133 locations a big player in the market for second-hand cars. Still it only reaches about 57% of the population, having a market share of about 5% in the markets in which it is present. This leaves huge growth opportunity in a still fragmented market. In the period 2015-2017 it hopes to open 10-15 stores per annum, expanding from 133 stores currently to 164-174 stores by 2017.

The receivable finance portfolio has risen to $7.4 billion at the moment. The unit reported earnings of $336 million over the past year, but note that the allowance for loan losses is just $75.4 million as of the end of the past quarter. Besides continued store growth, other areas of focus are the website and mobile applications and further focus on efficiency.

Valuation

CarMax ended the quarter with $532.2 million in cash and equivalents. The company has $7.6 billion in non-recourse notes payable related to the financing company. Corporate debt and lease obligations total about $336 million.

For the year ending in February of this year, CarMax posted revenues of $12.57 billion on which it earned $492.6 million.

Factoring in the huge 16% jump on Friday, with shares trading at $52.75, shares are valued at $11.65 billion. This values CarMax's equity at 0.9 times sales and 23-24 times last year's earnings

CarMax does not pay a dividend, but uses earnings to continuously grow the business. The company is repurchasing shares at a modest pace, still having $1.1 billion in repurchases being authorized.

Some Historical Background

CarMax has shown continues and steady growth over the past decade. Between 2005 and 2014 CarMax has grown revenues at a compounded annual growth rate of about 10%. Earnings have grown even more rapidly, but what is really comforting is that the company managed to avoid losses even in the downturns despite the large finance business. Effective credit management including securitization programs is helpful in managing these risks.

Important to realize is that strong operational growth, through store openings, and a strong economy are fueling results. As a result shares have risen to all-time highs at the moment. Shares fell from levels around $25 in 2007 to just $8 during the recession to recover to current levels.

Final Takeaway

CarMax's superstores are very efficient as the company aims open another 12 locations this year. Its 133 stores generate average sales of over $28 million over the past quarter, outright impressive results.

As the company already sold more than 250,000 cars during the quarter the company is approaching a run rate of a million cars per annum. These numbers of predominately used cars are simply staggering, although it should be noted that this quarter is the seasonally strongest quarter of CarMax.

As should be clear by now CarMax is not your average used-vehicle re-seller. Its continued and impressive growth pace over the past decade warrants a premium valuation in an otherwise very cyclical industry. The question is how big should that premium be?

At the moment shares trade on an earnings multiple in their low-twenties based upon forward earnings which is a bit steep given the seasonality and risks related to the financing business. On the other hand the company has a great track record of remaining profitable, even during the rough years.

Even so, current earnings are above long term averages which makes me cautious, prompting me to stay on the sidelines.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.