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There has been some recent statistics that have been reported that credit is definitely flowing again in America. One area that has seen strong growth is in the area of auto sales. According to the American Banker, the amount of outstanding in auto loans has increased by $23.9 billion YOY, from $658 billion. They also note that the increase in auto loans was because of banks pushing for subprime loans (haven't we been through this before).

The question remains is how can an investor profit from the increase in auto's sales. A company to consider is CarMax (NYSE:KMX) based in Richmond, VA. Currently, CarMax operates 107 used car superstores in 52 markets, and plans to open 10 to 15 stores and more to come.

CarMax is currently down 13.26% for the past 52-weeks. They are currently trading at 17.2 X P/E, which is above their industry peers that are trading at 15.6X P/E. Their balance sheet remains strong as their current ratio sits at 3.1, as compare to their peers that sits at 1.0. The management team is doing a phenomenal job on the return on assets (5.73%) and the return on equity (17.01%), which both are above their industry peers. CarMax sales have seen consistent growth, as compare to their industry peers; however, their earnings per share have lagged their peers for the past year.

In its 3rd quarter report, CarMax reported a profit of $82.8 million or $0.36 per share, as compared to the same period in 2010 of $82.4 million. The company reported an increase of gross profit from $297.9 million to $303.2 million YOY; the gross profit was higher due to higher sales in Used and Wholesale vehicle sales, but their margin decreased by 0.7% during the same period last year.

There are however some concerns with CarMax:

  • Their Used Vehicles units declined by 1% due to higher unit selling price.
  • Their New Vehicles units declined by 13% due to higher unit selling price.
  • Their Wholesale Vehicles units increased by 13% even with higher unit selling price.
  • CarMax Auto Finance unit: It seems that management has decided to finance majority of their sales as their receivables have increased by 12.5% YOY. Their net loan origination increased by 34% YOY. As CarMax reported in their press release: "The increase reflected of previously reported decision to retain an increased portion of the loans that third-party providers had been temporarily purchasing." It also added that "provision for loan losses increased to $15.1 million from $8.6 million in last year's third quarter, primarily reflecting the cumulative effect of the origination and retention of loans with greater credit risk."

Takeaways:

  • Even though CarMax unit sales declined, they were able to make a gross profit during the 3rd quarter through higher vehicle cost. This can be a cause of concern if the unit sales continue to decline, and margins start to squeeze.
  • The CAF unit is taking advantage of the low cost of funding to them by the low interest rates, and what CarMax is charging the car buyer in interest payments. This is an understandable and commendable move by the management team. The concern will be if the economy starts to weaken again, and the auto loan receivables can take longer to be paid off; this will impact the bottom line for CarMax. The fact that CarMax has increased the provisions for loan losses due to "greater credit risk" should be an eye opener to current and future investors alike. As reported by MarketWatch, according to Fitch Ratings, in discussing the Auto ABS it states that "prime 60+ days delinquencies rose 2% to 0.51% in January month-over-month…in the subprime sector, performance slowed MOM with 60+ days delinquencies and ANL rising in January. Delinquencies were 3.31% in January, a 3.8% increase but 5.2% below January 2011." Although Fitch describes this as a seasonal increase, investors should be keeping an eye on monthly delinquencies since CarMax is financing their sales.
  • If auto loan delinquencies continue to rise, credit may become scarce and CarMax expansion will slow down.
  • The increase of gross profit of 12% by CAF helped CarMax's bottom line. If there is any deterioration in credit quality and increase in provision for loan loss, this will impact the company's bottom line.

There are a few hopeful signs for CarMax:

  • According to J.D. Power, vehicle sales will reach 14 million units 2012. This will help CarMax's top line, and will help the companies profit as long as sale margins do not decrease much.
  • In January, there was a weakening of used car prices as it declined by 1%, following a drop of 0.7% in December; however, used vehicle prices are higher by 3.2% since January of 2011. This will make vehicles more attractive to the consumer, but should have minimal impact on the gross profit.

Now we know both the positives and the negatives with CarMax. Question: Will the stock drive growth in your portfolio? CarMax is well position for future growth, and the fundamentals of the company remain strong. CarMax does not pay a dividend, as they should not as they are in expansion mode. There are a few items, as noted above, that investors should keep a look out for when CarMax reports their 4th quarter and Fiscal Year 2012 earnings on April 5, 2012.

The company can see an upside if both their Used and New Vehicles sales increase and margins are not compromise, and if the EPS increases by 7% at $0.39 per share QOQ for the 4th quarter.

See if CarMax drives your portfolio higher.

Source: Will Carmax Drive Growth In Your Portfolio?