CarMax: It's Quite Simple

| About: CarMax Group (KMX)
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CarMax is a very well-known company that operates as a retailer of used vehicles in the United States.

The once strong growth story has slowed.

I discuss Q1 results and what it means for the company and the stock.

CarMax (NYSE:KMX) is a very well-known company that operates as a retailer of used vehicles in the United States. The business is quite simple. It sells vehicles that do not meet its retail standards to licensed dealers through on-site wholesale auctions, as well as sells new vehicles under franchise agreements. The company also provides customers financing alternatives through its finance operation, CarMax Auto Finance, as well as through its third-party financing providers. In addition, it offers a range of other related products and services, including the appraisal and purchase of vehicles directly from consumers, vehicle repair services and extended warranties. The business has been quite profitable but the stock is about flat over the last year. Here in the pre-market it appears the stock is about to head substantially lower, which caught my eye. So what is going on here?

Well, the company reported its Q1 earnings and while it was another very profitable quarter with growth, the company missed estimates on the top and bottom lines. In terms of underlying performance, the company saw total used vehicle unit sales grow 4% and comparable store used unit sales grow just 0.2% versus the prior year's first quarter. This growth is down markedly from the growth displayed in the last two years' comparable quarters. This same store sales performance reflects an improvement in conversion that more than offset a decrease in store traffic. I was pleased to see that wholesale vehicle unit sales grew 1.8%, though this is less than the growth in prior years. Wholesale unit sales benefited from a larger store base.

So-called 'other sales' and revenues dropped 10.9% year-over-year. Extended protection plan revenues (which includes extended service plans and guaranteed asset protection revenues) increased a strong 6.3% versus the prior year level, reflecting growth in retail sales units. Net third-party finance fees were, however, up a strong 30% from last year's first quarter, primarily due to the reduction in the proportion of sales attributable to those being financed by third parties.

So overall, sales were on the rise, albeit with slower growth than we are accustomed to, but what about overall profit? Well, total gross profit increased 5.3% to $572.6 million in the quarter. Further, used vehicle gross profit rose 4.1%, driven by the increase in total used unit sales that I mentioned above, while used vehicle gross profit per unit remained comparable with the prior year period. Wholesale vehicle gross profit actually decreased 1.9% versus the prior year's quarter, driven by lower average sales prices. Finally, due to the rise in third-party fees, so called 'other' profit jumped 21%.

One downside is that in order to generate these sales and higher profits, expenses rose. In fact, they rose at a pace that was greater than the increase in sales. Selling, general and administrative expenses increased 8.7% to $380.2 million, primarily reflecting the 11% increase in the company's store base in a year's time. CarMax Auto Finance income also dropped by a noticeable 7.7% to $108 million, driven by an increase in the provisions for loan losses. Interest expense rose to $11.1 million in the first quarter of fiscal 2017 from $7.1 million in the prior year's quarter.

Despite the slowing sales growth, I do like that the company has a nice share repurchase program. During the first quarter, CarMax repurchased 2.6 million shares of common stock for $132 million pursuant to its share repurchase program. As of May 31, 2016, it had $1.27 billion remaining available for repurchase under the program. That said, the stock has suffered because of the stalling growth. And because of this, it's quite simple. I rate the stock a sell until the company can return to the strong growth story it once was.

Note from the author: Christopher F. Davis has been a leading contributor with Seeking Alpha since early 2012. If you like his material and want to see more, scroll to the top of the article and hit "Follow." He also writes a lot of "breaking" articles, which are time sensitive, actionable investing ideas. If you would like to be among the first to be updated, be sure to check the box for "Real-time alerts on this author" under "Follow."

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

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.