CarMax: Buy Yourself Something Nice

Summary

• Sales have slowed a bit, and margins are being pinched as the company pushes for volumes.
• Federal stimulus has been a benefit and will boost Q1.
• Earnings growth has stalled.
• Repurchasing shares and acquiring all of Edmunds is a win.
• At these levels back out the initial investment plus something extra and let the rest run.
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CarMax (NYSE:KMX) is stock that we highlighted after the major selloff a year ago as stock that we felt was a buy on weakness and had pandemic tailwinds. Sales have been growing over time, but this is a heavily saturated market, and with a consumer economy that is on the mend. With rates on the rise again, some believe new auto sales will rise as consumers rush to lock in strong rates. This remains to be seen, but CarMax is holding its own. The stock took a breather in the fall, and we said once again that it was buy if it fell into the $80s, which it did, and traders saw gains of 60% in a few months.

The critical question now is what to do now that the stock has given us such returns? After the just reported earnings, we see both positives and negatives. We think most of the key metrics are strong, though valuation is stretched here. We think a hold is fine, but traders should take some profit here. We think you should follow the advice we often give our members when they have serious gains like this. And that is to take out the initial investment, plus a little something extra to buy yourself something nice, and let the rest run. New money should wait for a pullback before considering a new position. The just reported quarter reflected fundamental improvement going forward.

Revenues spike, though explosive growth is likely a thing of the past

CarMax's just reported earnings and revenues were once again up from a year ago, beating estimates on the bottom line. The used car market picked up a bit during COVID, but sales were up marginally versus a year ago, suggesting some normalization is on the way. As we will see in a moment, the huge growth seen in mid-2020 seems like it is fading now. That said, Q4 revenues were $5.16 billion, in line with estimates, rising 4.0% from last year. While COVID-19 was a unique tailwind, we do not see a path forward for CarMax to have consistent large increases in revenues. Instead we think it will remain a slow grower on the top line. This is because CarMax has spread across the U.S., not to mention strong competition. This could change with immense international expansion, but right now this is just speculation on our part. What we are seeing are mixed results in the critical metrics that we follow for CarMax.

Critical metrics mixed

Despite the positive headline news, the critical metrics we follow for this company were mixed. Total used vehicle unit sales actually fell 0.9% in the quarter and comparable store used unit sales fell 2.9% versus the prior year's fourth quarter. We were looking for comps that were about flat. However, there was a bit of a calendar shift in the comparisons that contributed to some negative impact, but it should also be noted Q4 likely saw a benefit from the stimulus payments under the Trump administration, and possibly Q1 will see a benefit from the Biden administration's recent stimulus. If we exclude the added benefit of leap day in the prior year quarter, both total used unit and comparable store sales would have increased slightly year-over-year, in line with our expectations. .

Comparable store sales performance reflected ongoing positive trends in customer conversion, continued support from financing, and growth in web sales. A big ad campaign helped in December as well, which bolstered new customer offerings. The one big negative was the middle of February when severe winter weather hammered much of the U.S, leaving many without power etc.

Wholesale also saw declines, but this segment has been up and down. Wholesale units decreased 1.2% from a year ago, though some of this was from the leap year impact we mentioned above. Turning to the service plans and financing side of the business, revenues were also down 1.9%.

As far as the top line is concerned, it was overall about what we expected, though the path to get there was different. We thought wholesale would be weaker, and service revenues are always a bit unpredictable, but the comparable used sales figure was below our expectation as reported, but in line if adjusted for leap year. Either way, the trends are not enormously positive in the sales figures here. While earnings beat consensus, they were below our expectations slightly, and this is because margins were pressured.

Profit power dips

Total gross profit fell 8.5% to $752 million in the quarter. This was a result of weakness across segments, as well as big increases in spending thanks to an ad campaign in the winter.

The key metric we follow is used vehicle gross profit per unit. This fell markedly versus the prior-year period, down $109 per vehicle thank to pricing adjustments during their lower pricing tests. We expect pressure here in 2021 if pricing reductions continue. Wholesale vehicle gross profit was down 1.5% driven by lower volumes, and a near flat per vehicle profit of $990.

Selling, general and administrative expenses rose 15% to $556 million. Advertising expenses were up heavily, as was stock-based compensation expenses. On a per used unit basis, selling and administrative expenses were $2,713, up $368 year-over-year. That is a meaningful increase, and is reflective of the push by the company to drive more volume, while cutting into profit. We believe the results of this experiment have been mixed. While volume may have been lower without the pricing, the question is whether or not they would have been so much less that per unit profit would not have made up for it.

With the strong top line and expenses that grew minimally, the bottom line beat consensus expectations. Earnings were 1.27 (below our expectations for $1.30), but beating by $0.02 per share. This was down from a year ago. We thought earnings would be about flat.

Looking ahead

Sales have slowed a bit, and margins are being pinched as the company pushes for volumes. Comparable store used unit sales may get a boost in Q1 from the latest stimulus. Based on the results, shares should fall some, as they are now over 30X. But there are two reasons why shares are a buy if they fall back to a more reasonable $100 per share in our opinion, or should be held with a house position as we suggested in the open. First, the company is buying back shares. That is a positive, but we would suggest management wait for pull backs to also repurchase them. Second, CarMax is acquiring all of Edmunds per the earnings release, and that inorganic growth is welcomed as the market saturation issue is real. With planned capex to ramp up over the next few years, the company is in good shape. But we think investors have to wait for the stock to take a breather, which is underway as we write.

Analyst’s Disclosure: I am/we are long KMX. 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.