CarMax's Weak Results May Actually Be Positive For Automakers

| About: CarMax Group (KMX)

Used-car giant CarMax (NYSE:KMX) reported earnings for the first quarter of its 2013 fiscal year on Thursday. Revenue and earnings for the quarter came in below consensus estimates. The firm earned $0.52 per share, a touch shy of the $0.53 the Street expected, while revenue was $70 million shy of consensus estimates. Same-store unit sales for the firm's used car segment and its new car segment were both flat, but sales dollars were up 2% and 3%, respectively. Average selling prices (NASDAQ:ASPS) across used and new car segments were up on a year-over-year basis, but wholesale prices remained basically flat compared to the same period a year ago.

CarMax intends to open 10 dealerships in its fiscal year 2013, up from 5 in fiscal year 2012. The firm has continued to take advantage of constrained supply and thus favorable pricing in the used-car market, as its gross profit in the segment increased 3%. Gross profit per unit in this segment did decline 20 basis points when compared to the same period a year ago, but that number translates to roughly $3 per unit. Total used-car unit sales also increased 3% compared to the first quarter of last year.

Meanwhile, new car unit sales actually fell 13% for the quarter, though average profit per unit increased by 60 basis points and gross profit increased 13% for the segment. Some headlines attributed the sell-off in shares of the dealership company to falling new car sales; however, we think this overstates the importance of new cars to the firm's overall sales and profit mix. For the quarter, CarMax sold 2,107 new cars, which equates to about 1% of its total unit sales. We do not view CarMax as a new-car destination, so we don't think this has any negative read-through on our broader industry thesis. If anything, the stronger pricing for new vehicles underscores higher ASPs for automakers like Ford (NYSE:F), Toyota (NYSE:TM), and GM (NYSE:GM).

CarMax's fall in wholesale revenue and profitability may also underscore improvements in the broader economy. Wholesale cars are deemed "not suitable" for the normal CarMax retail channel so the cars are then sold at auction at substantially lower prices. Though CarMax pays less to acquire these vehicles, we think consumers may be more interested in buying certified used and new cars, rather than a car bought at auction that might not hold up. New and certified used cars should, in theory, require less maintenance over the near-term, so perhaps consumers are making higher initial investments to avoid expensive repair costs. Further, with CarMax doubling its dealership openings this year, we do not think the company is too worried about the health of its business.

After reviewing the quarter, we don't think CarMax's results were that bad, and we think the broader implications of the results are actually positive. As we stated earlier, new cars are not a meaningful part of the sales mix at CarMax, so we think it has little meaning for new-car sales on a macro level. Further, a drop in wholesale vehicle sales may actually signal greater consumer confidence rather than a weakening economy. Nevertheless, we think shares are fairly valued at currently levels. Our favorite name for exposure to the automotive industry remains Ford, as we think the firm's shares trade at a substantial discount to their intrinsic value and that the market is underappreciating the changes in cost structure and operational leverage inherent to the firm's business model. We currently hold shares of Ford in the portfolio of our Best Ideas Newsletter.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: F is included in the portfolio of our Best Ideas Newsletter.