CarMax: Ride Or Die?

| About: CarMax Group (KMX)
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Summary

I had a sell rating on this growth story until the US elections where I rated multiple sectors and the stock market as buys, including CarMax.

I discuss recent performance of the company.

Is there room to run or is the rally over?

CarMax (NYSE:KMX) is a well-known company that operates as a retailer of used vehicles in the United States. 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 operations. It also 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 has suffered. I have had a sell rating on the name, and that was the right call up until the election of Donald J Trump, which led to a massive market rally, particularly in consumer goods, finance and similar industries. After the election I told you stocks were a huge (yuuuuuuuuuge?) buy, and the precious metals would get hit. AS far as CarMax is concerned, the election had nothing to do with performance. So let us check in on the name.

The company just reported its Q3 earnings and while it was another very profitable quarter with growth, the company missed estimates on the top line but beat on the bottom line. In the past few quarters it had been missing on both lines. In terms of underlying performance, the company saw total used vehicle unit sales grow 9.1% and comparable store used unit sales grow 5.4% versus the prior year's third quarter. This growth is down markedly from the growth displayed in the last two years' comparable quarters however. This same store sales performance reflects an improvement in conversion that more than offset a decrease in store traffic. I was disappointed to see that wholesale vehicle unit sales fell 2.2%. This was a direct result of said traffic declines.

So-called "other sales" and revenues were up slightly by 1% year-over-year. Extended protection plan revenues (which includes extended service plans and guaranteed asset protection revenues) increased a strong 14% versus the prior year level, reflecting growth in retail sales units. Net third-party finance fees were, however, up a strong 33% 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 8.4% to $503 million in the quarter. Further, used vehicle gross profit rose 8.8%, driven by the 9% 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 7.3% versus the prior year's quarter with aforementioned sales declines. Finally, due to the rise in third-party fees, so called "other" profit jumped 27%.

Now, in order to generate these sales and higher profits, expenses rose. Selling, general and administrative expenses increased 5.7% to $356 million, primarily reflecting the 11% increase in the company's store base in a year's time. CarMax Auto Finance income also dropped by 23.2% to $89.4 million, driven by an increase in the provisions for loan losses. Interest expense rose to $15.1 million from $10.0 million in the prior year's quarter. All in all, these rising expenses resulted in a narrowing interest margin to 5.8% from 6.0% last year.

This is one of the better quarters we have seen in a while. That said, there are still weaknesses in wholesale and in finance. Once again, even with the slowing sales growth, I continue to like that the company has a nice share repurchase program. During the second quarter, CarMax repurchased 3.8 million shares of common stock for $198.7 million pursuant to its share repurchase program. As of November 30, 2016, it had $1.69 billion remaining available for repurchase under the program. While a reduced share count of course benefits earnings per share, the company is still under pressure. I think the recent rally has run its course, and I would take profits here. I am lifting my prior buy call on the sector, and calling for a sell once again here.

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 that are time sensitive. 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.