CarMax: Create a Synthetic Dividend From This Revving Growth Engine

| About: CarMax Group (KMX)

CarMax (NYSE:KMX) shares have retreated of late, with investors pushing shares from a 52-week high at $37.02 earlier this year to a price in the mid- to high 20's. Investors are overly concerned with a weak macro environment because CarMax's no-haggle business model continues to work. For the FY ended 28 February 2011, CarMax’s revenues increased 20% to $8.98 billion, and GAAP EPS rose by 32.5% to $1.67. The next earnings release is on June 22. For Q1 2012, analysts estimate that the company will earn $0.48 per share, an increase of 8.08% over Q1 2011, and generate revenues of $2.5 billion, an increase of 11.06% over Q1 2011. The company also has a debt to equity ratio of 1.8.

Other companies, like AutoNation Inc (NYSE:AN), Group 1 Automotive (NYSE:GPI), Penske Automotive Group (NYSE:PAG) and Sonic Automotive (NYSE:SAH), have tried to mimic CarMax's business model in the past and failed, leading us to believe the company has carved out a competitive moat. This leg up on the competition will allow CarMax to expand profitably once macroeconomic conditions improve.

In 2010, U.S. light vehicle sales volume rebounded 11%, to nearly 11.6 million. For the automotive retailers sub-industry, S&P believes that the bottom has been reached in the current sales cycle. We agree, and place a price target of $37 on the stock, which offers significant capital appreciation.CarMax currently operates 104 used car superstores in 50 markets.

For interested buyers, we suggest a covered call strategy. We like the July and October 2011 sold calls and January 2012 sold calls. These permit 7-8% appreciation over one to seven months, and a synthetic yield of 2% in one month to 12% in seven months, respectively.

Call Options
Expires Symbol Last Chg Vol Open Int
11-Jul KMX110716C00029000 0.7 0 5 351
11-Oct KMX111022C00029000 1.96 0 4 27
12-Jan KMX120121C00029000 3.1 0 11 11
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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.