Domestic Sales Growth Makes CarMax More Attractive

| About: CarMax Group (KMX)

The economy has created a new generation of do-it-yourself mechanics. Learning the ins and outs of oil changes, starters and alternators has been great for auto supply stores, including AutoZone (NYSE:AZO), which I wrote about recently. But it's also been good for used car dealers, such as used car superstore operator CarMax (NYSE:KMX).

Used cars have been in vogue since the recession. The overall age of cars is driving demand for late model and certified used vehicles, which provide a solid alternative to depreciation-prone new cars.

The Manheim Used Vehicle Value Index hit a record peak this summer before backing off through fall. In November, the measure turned higher again, recording its second highest reading since its creation in 1995 - despite more retired rental units being sold at auction.

This suggests consumers, wary of European headline risks, are again turning back to used cars. With industry unit sales up 3.4% in November, CarMax, which is the largest used car dealer in the U.S. with 106 car superstores in 51 markets, stands to benefit.

Currently, the company's stores reach just shy of 50% of the U.S. population, which means there is plenty of room to grow. Back in 2008, the company shelved its expansion plans in order to conserve capital through the recession. Now, with consumers back on dealer lots, CarMax has resurrected its growth plans. It opened three new stores in FY2011 and has plans to add another five in FY2012. In FY2013, the company aims for an additional 8-10 stores. If targets play out as expected, the company's sales and earnings will benefit handsomely from this 15% increase in storefronts.

Last quarter, sales were up 11% to $2.59 billion. Vehicle revenue, which accounts for 77.9% of sales, rose 7% to $2.01 billion as selling prices climbed 7%. The company's wholesale revenue, generated from trade-ins and appraisal buys of vehicles too old to resell on its own lots, jumped 39% to $457.9 million as unit sales rose 23%.

The bump in the wholesale market, likely a function of a continuing stagnant job market, boosted the segments share of revenue to 17.7% of total revenue, up from 14.1% last year. But, even with more wholesale cars hitting the market, demand has been brisk enough to support prices. The company saw its average wholesale price increase 13% in the quarter from the prior year.

CarMax doesn't just make money selling cars. It also finances them through its finance arm, CAF. CAF financed 39% of vehicles the company sold in FYQ2, which helped segment income climb 21% to $63.8 million.

Short-sellers are starting to rein in their pessimism too. The number of shares held short fell to 18.58 million from 19.43 million in the past month. But, even with that covering, short interest stands at 7.1 days of average volume, which suggests a solid floor underneath the stock, particularly if numbers come in strong for the quarter.

As investors digest ongoing risk overseas, they're increasingly hunting for stocks tied to the U.S. economy, which despite sluggishness is still showing evidence of improving default and delinquency rates. A solid plan for future store growth and ongoing consumer interest in used cars makes CarMax and intriguing play for U.S.-focused portfolios.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in KMX over the next 72 hours.