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At 2.5% market share CarMax (NYSE:KMX) is more than twice as large as the next closest competitor in the used car sales industry. With only 107 stores, CarMax is an enticing regional to national growth story with years of growth still ahead of it. On the downside, CarMax is the Best Buy (NYSE:BBY) of used cars - the place you go for a product demo before you buy online for less.

Five Forces Model Analysis

Threat of New Entrants: High fixed costs for inventory and access to channels of distribution are the largest barriers to entry for the industry. Economies of scale benefit the firms competence but do not inhibit new entrants.

Intensity of Competition: From individual car owners to established car dealers, the industry is extremely competitive and customers are price-sensitive.

Bargaining Power of Suppliers: Suppliers have the potential capability to integrate forward in order to directly sell to customers.

Bargaining Power of Buyers: Customers are price sensitive and have no switching costs.

Threat of Substitutes: Alternatives exist but most people simply need a car.

Value Chain Analysis

Even though the used car industry is extremely competitive and price sensitive, CarMax does well because it has huge economies of scale. With large inventory, the company can spread its operating costs consistently across individual dealerships. CarMax adds value in five categories.

Acquiring Cars - Most of the cars are acquired through trade ins. This creates a high quality inventory. CarMax offers a "while you wait" appraisal and gives you an offered that is valid for seven days. They also acquire cars through dealership relationships such as auction houses.

Managing Inventory - This is the company's real competitive advantage. All inventory goes through a standardized internal inspection process. Cars are separated into "CarMax" and "Valumax" categories and sold through channels focusing on different categories of quality and price.

Operating Stores - Management policies guarantee a consistent customer experience across the company and inventory is shared nationwide.

Marketing and Selling - Website searching, "no haggle" price policy, and inspection guarantee are the key components of the companies value added strategy.

Services - The company differentiates itself from smaller dealers by offering financing, appraising, repairs, guarantees and warranties for every sale.

The process of inspecting and guaranteeing the quality of the cars CarMax re‐sells adds considerable value to company's brand. This type of service is not likely to be found in other dealerships. The amount of resources that go into the value‐chain activity of managing and sorting CarMax's inventory is difficult to implement, and hard to imitate. While CARFAX Reports offer the same assurances of quality, they cannot offer the other benefits such as auto service and repairs, warranties, and financing.

SWOT Analysis

  • Strengths - High quality vehicles, large inventory, no haggle prices, customer friendly sales
  • Weaknesses - High Prices
  • Opportunities - Nationwide expansion, improved customer service, backwards integration to the supplier level
  • Threats - Overhead costs rise with each new store, poor economy, competition

Valuation
The assumption is that the company should be able to expand its store base around 10% per year and continue to grow organically, resulting in 15% growth. Assuming 15% annual growth the company should earn around $4.20 per share in 2017. At a market multiple of 15 times earnings you get a projection of $63 per share. Thus, if you are able to buy shares at $31.50 or better you can anticipate doubling your investment in 5 years, for a 15% yearly return.

That's a rosy assessment. Obviously this assessment carries risk. While a poor economy hurts sales, this cuts both ways. In a truly robust market consumers might choose to purchase new cars, while a moderately slow economy encourages customers to trade down to used cars.

The biggest threat to this company is the "Best Buy" problem. CarMax's website and transparent appraisal process make it an excellent place to go kick the tires and make an informed purchasing decision. The problem is that many customers will be making that purchase online from a lower cost provider. Although CarMax's customer-centric shopping environment and service offerings provide some differentiation, I'm not convinced that price sensitive customers will be willing to pay for the value added services that CarMax provides. According to this report, CarMax cars cost on average $2,000 more than the same car from a private party. The loan services, 7 day money back guarantee, 30 warranty and guaranteed services after purchase are nice. Will customers continue to pay up for them?

Conclusion

CarMax is a great growth story and they benefit from a network effect. CarMax offers the largest selection of used cars in the country. As this model attracts new purchasers, more of them sell their old cars to the company, which enhances the selection further and leads to still more customers. Longer term I think the price gap between CarMax and private parties will shrink as economies of scale take effect. Thus strengthening the value added proposition. Shares look fairly valued for the moment, but you never know when opportunity will knock.

In parting I will offer you this. A better investment mind then mind, Tom Gayner of Markel (NYSE:MKL), had this to say about the company:

I think that is a business that will continue to grow. I don't see any reason why you can't have a Carmax in a lot of towns way beyond what they're talking about right now. I think being the number one dealer, and having the number one market share in used car arena gives you great information on what transaction prices are. Then you work on the process to be as quick and as cost efficient in fixing the car and getting it sold, and have the confidence from customers when you offer warranties on the products. Those factors create a virtuous cycle. The more you do, the more you can do, the better the pricing is, the more the customers like you, the more your brand matters. The company will be around for a good long time. The management has done a very good job of creating the system and executing it.

Sources
Glowicki, J. (n.d.). Ins and Outs of CarMax. from HowStuffWorks; Gurufocus.

Source: CarMax, A Growth Story