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CarMax Inc. (KMX) posted a 25% rise in profit to $126.3 million or 55 cents per share in the first quarter of the fiscal year ended May 31, 2011from $101.1 million or 44 cents per share in the prior fiscal year-quarter. The profit exceeded the Zacks Consensus Estimate by 8 cents per share.

The increase in profit was attributable to improved customer traffic and higher unit sales, partially offset by a fall in sales conversion rate. This is reflected in the 6% improvement of comparable store sales for the quarter.

Net sales and operating revenues in the quarter appreciated 18% to $2.68 billion, which was higher than the Zacks Consensus Estimate of $2.52 billion.

Used vehicle revenues grew 13% to $2.07 billion. Unit sales increased 7.5% or 7,586 vehicles to 108,511 vehicles while average selling price increased by $938 to $18,902. Meanwhile, new vehicle revenues rose 22% to $61.9 million. Unit sales rose 14% or 301 vehicles to 2,435 vehicles while average selling price increased by 7% or $1,567 to $25,288.

Wholesale vehicle revenues shot up 51% to $477.8 million, primarily driven by a increase in unit sales of 32% or 20,703 vehicles to 85,062 vehicles. The higher unit sales resulted from a significant increase in appraisal traffic combined with the benefit of a continued strong appraisal buy rate.

Other sales and revenues inched up 9% to $68.2 million, driven mainly by a rise in extended service plan (ESP) revenues.The 12% increase in ESP revenues to $46.3 million reflected both the growth in retail vehicle sales and better penetration of ESP.

Total gross profit swelled 15% to $383.1 million from $333.5 million in the quarter, primarily reflecting increases in used and wholesale unit sales. Total gross profit per retail unit went up $217 to $3,453 in the quarter from $3,236 per unit in the corresponding quarter a year ago.

Selling, general and administrative expenses (SG&A) increased 9% to $248.2 million from $226.7 million in the prior year’s quarter. The increase in SG&A primarily reflected increases in sales commissions and other variable costs associated with the growth in unit salsas as well as higher advertising expense. Meanwhile, cost of sales increased by 19% to $2.30 billion from $1.93 billion a year ago.

CarMax Auto Finance (CAF)

The income from CAF increased to $69.7 million from $57.5 million in the first quarter of fiscal 2011, driven by higher interest margin. The provision for loan losses was a credit of $1.0 million compared with an expense of $0.9 million in the prior year’s quarter.

Net charge-offs in both periods were significantly lower than the company’s forecast and previous trends. The lower-than-expected losses and the resulting adjustments to the allowance for loan losses related to future periods favorably affected net income per share by 3 cents per share in both the first quarter of the current year and of the prior year.

CAF net loans originated increased 33% compared with the first quarter of fiscal 2011, which reflected both the growth in retail vehicle sales and the company’s decision to retain an increasing portion of the loans that third-party providers had been purchasing since CAF’s tightening of lending standards in 2009.

Financial Position

CarMax had cash and cash equivalent of $156.0 million as of May 31, 2011, which was significantly higher than $13.7 million in the corresponding period a year ago. Total debt reduced significantly to $30.1 million as of the above date from $86.5 million as of May 31, 2010. Consequently, debt-to-capitalization ratio improved to 1.22% from 4.23% a year ago.

In the quarter, CarMax’s cash flow from operations declined to $22.1 million from $56.6 million in the same period of prior year, despite an improvement in net income. The decline in cash flow was mainly attributable to increases in inventory and auto loans receivables. Meanwhile, capital expenditures increased significantly to $31.0 million from $9.2 million in the prior-year quarter.

Our Take

We appreciate CarMax’s focus on the used-car market, which helps it to outperform the industry. The automotive retailer is among the strongest operators in its peer group, which includes AutoNation Inc. (AN) and Penske Automotive Group (PAG).

In the first quarter of fiscal 2011, CarMax resumed its strategy to open new used-car superstores, driven by improved economic and sales environment in the U.S.Under the strategy, the company plans to open used car superstores at an annual rate of 15%–20% of its used car superstore base every year.

During the quarter, the company has opened two used car superstores, entering the Baton Rouge, Louisiana, and Lexington, Kentucky, markets. It plans to open three more superstores in the current fiscal year in California, Massachusettsand Tennesseeand eight and ten stores in the fiscal year ending February 28, 2013.

However, the tendency of manufacturers and dealers to lure customers into trading old cars for new ones through incentives puts pressure on the company’s used vehicle margins. This, along with rising cost of sales, has led the company to retain Zacks #4 Rank on its stock, which translated to a short-term (1–3 months) recommendation of “Sell”.

Source: CarMax Profits From Higher Sales