CarMax Earnings Preview

| About: CarMax Group (KMX)
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CarMax Inc. (NYSE:KMX) announced that it would release its results for the fourth quarter and fiscal year 2011 before the market opens on March 31, 2011. The nation’s largest retailer of used cars earned a profit of 36 cents per share, thus exceeding the Zacks Consensus Estimate of 34 cents.

In the upcoming quarter, the Zacks Consensus Estimate for the company is pegged at a profit of 38 cents per share, reflecting an annualized growth of 47%. However, for full fiscal 2011, the Zacks Consensus Estimate is $1.66, implying an annualized growth of 42%.

With respect to earnings surprises, the company outdid the Zacks Consensus Estimate in the trailing four quarters. This is reflected in the average earnings surprise of 15.8%, implying that the company has beaten the Zacks Consensus Estimate in each of the last four quarters.

The largest difference was observed in the first quarter of fiscal 2011 while the lowest gap was recorded during the fourth quarter of fiscal 2010.

The current Zacks Consensus Estimates for the fourth quarter and full fiscal 2011 are profits of 38 cents and $1.66, respectively. The upside potential of these estimates, essentially a proxy for future earnings surprises, are 5.26% and 1.21%, respectively.

Third Quarter Review

CarMax’s profit during the period was favorably impacted by a rebound in customer traffic and an improvement in sales conversion driven by better availability of consumer credit.

Used vehicle sales augmented 20% to $1.69 billion, whereas new vehicle sales escalated 25% to $47.7 million. Wholesale vehicle sales also increased 41% to $320.1 million, driven by increase in appraisal traffic as well as appraisal buy rate. Extended service plan (ESP) revenues rose 31%, incorporating the growth in used unit sales and an increase in ESP penetration.

Increased sales and revenues also raised the total gross profit by 23% to $297.9 million from $242.9 million a year ago. Alongside, the company’s selling, general and administrative expenses climbed 14% to $219.7 million. The increase in costs was attributable to increased sales commission, higher advertising expense and growth in other variable costs associated with the improved sales.

CarMax Auto Finance had tightened its lending standards during the period under study. Consequently, the income from this segment fell to $55.7 million from last year’s $65.8 million.

Estimate Revisions Trend

The fourth quarter earning estimate increased over the past 30 days by one penny to 38 cents, translating into a growth of 46%. However, full fiscal year 2011 earnings estimate remained unchanged at $1.66 over the past 30 days, depicting a growth rate of 43%.

Agreement of Estimate Revisions

Out of the 13 analysts covering the stock for the fourth quarter of fiscal 2011, as many as 5 have revised their estimates upward over the past 30 days. However, only one has upgraded the stock in the past one week. None has downgraded the stock though.

Almost similar trends have been observed for full fiscal 2011 as well. 4 analysts out of the 13 covering the stock for the full fiscal 2011 raised their estimates in the past 30 days. One of them did so in the past one week. Again, none has downgraded the stock.

Although some of the analysts showed increased confidence in the company, most remained cautious.

Magnitude of Estimate Revisions

Over the last 30 days, estimate for the fourth quarter went up by one penny to 38 cents while the full-year estimate has been kept unchanged at $1.66. This is attributable to CarMax’s improved sales during the last quarter. With the gradual recovery of the U.S. auto industry, the company may expect further improvement in sales, particularly used cars.

Our Take

CarMax is considered one of the strongest auto retailers in the U.S. In the last few quarters, the company performed strongly with substantial improvements in used-vehicle sales. The success can be attributable to its strategy of opening new used-car superstores at an annual rate of 15%–20% on its used car superstore base every year. Going forward, this is expected to generate more positive results for the company.

Increased expenses on advertising and other marketing initiatives have also proved to be helpful in raising customer awareness. One big step was to shift focus from the print media to the Web, which the company did successfully.

However, major headwinds in the form of a depressed economy, a slow recovery and an unstable credit market still remain for CarMax. All these influenced CarMax shares’ rating and recommendation. CarMax Inc. shares currently hold a Zacks #3 Rank (‘Hold’ rating) in the short term and a ‘Neutral’ recommendation in the long term.