Summary
- CarMax, Inc. has superior scale and structural advantages versus peers.
- The used car market has rebounded to start the year.
- However, CarMax, Inc. faces headwinds in 2023 and a relatively high stock valuation.
The structural advantages CarMax, Inc. (KMX) has built up over time makes it a great company, and the bar for Q1 looks beatable given a rebound in the car market to start 2023. However, KMX valuation is still relatively high, and 2023 overall will likely be a tough year for the industry.
Company Profile
CarMax, Inc. is the largest selling used car dealer in the U.S. The company sells cars both in-store and online, or a combination of both. Customers can complete their purchases at one of KMX's lots, receive delivery through express pickup, or have their purchased car delivered to them.
Unlike traditional dealerships, KMX sells its cars at a fixed price with no negotiations. Customers have the ability to take a 24-hour test drive, as well as get 30-day/1,500 mile money-back guarantee and a 90-day/4,000-mile limited warranty. The company says it typically focuses on vehicles that are between 0-10 years old that cost between $14,000 to $47,000.
KMX also provides financing to customers with strong credit. For fiscal 2022, it financed nearly 43% of its used vehicle sales in-house. The company also offers third-party finance options through various lenders for tier 2 and tier 3 loans. For tier 2 loans, KMX generally receives a fixed, pre-negotiated fee per contract. However, for risker tier 3 loans, it generally pays the lender a fixed fee.
KMX acquires vehicles through several sources. Typically between 36-41% come from consumers, although that jumped to 70% in fiscal 2022 with the advent of its instant appraisal offer program. It also procures vehicles for auctions, wholesalers, dealers and fleet owners.
For the older vehicles that KMX acquires, it will generally sell them at its wholesale auctions. In fact, the company is also the largest wholesale used car auctioneer in the U.S. These are typically cars 10 years old or older, with over 100,000 miles. Generally, about half the cars it acquires are auctioned, while the other half are sold at retail.
Opportunities
With over 200 locations across the country, CarMax, Inc. has unparalleled scale in the U.S. used car industry. That said, the used car market is still very fragmented and local, and KMX has plenty of room to still expand its physical presence. The company also has the advantage of being able to transfer its huge inventory to any of its locations to meet customer needs.
KMX's growing digital offering is also another opportunity. Its omni-channel approach gives it an advantage of reaching customers in different ways who have distinct levels of comfortability in buying a car online. The company also has an enormous amount of data that it can leverage given the number of transactions, credit applications, and digital interactions it sees each year. The company is continuing to invest to bolster its online and mobile experiences.
KMX also has a procurement advantage through its ability to acquire so many vehicles from customers. Vehicles bought through customers generally have higher margins than those bought at auction or elsewhere. As the #1 car buyer in the U.S., the company has a copious amount of data to price its purchases correctly.
Along these same lines, its instant appraisal product is a nice growth driver. This not only helps the company procure more cars to sell, but it can make a profit on cars not fit for retail through its wholesale auctions as well.
Risks
The used car market has been very volatile the past couple of years, which certainly has had an impact on CarMax, Inc. and others in the industry. Used car prices started surging in the fall of 2021 due to a lack of supply of both new and used cars. However, that started to reverse in the fall of 2022, with prices tumbling. Used cars are generally depreciating assets that dealers want to quickly move, and the industry was very happy to see rising prices. However, rapid price declines at the end of last year left dealers scrambling to sell vehicles. Prices have rebounded a bit so far in 2023.
Auto financing metrics have also been weakening. Ally Financial (ALLY), which is one of the largest auto finance companies in the country, noted in Q4 that the percentage of 60-day delinquent loans in its portfolio rose to 0.89% from 0.48% a year earlier.
In addition, auto repossessions are also reportedly on the rise. According to NBC News, some repo companies are having difficulty keeping up with demand.
Commenting on the environment , Edmund's Ivan Drury said:
"Vehicle equity is really a tale of two gears for consumers over the past few years. At the onset of the pandemic, consumers benefited from low interest rates and elevated trade-in values, helping shield even the more questionable financing decisions from resulting in negative equity. This unique confluence of market forces resulted in some vehicle owners being able to take advantage of positive equity on their loans and even their leases. But as we shifted toward an environment with diminished used car values and rising interest rates over the past few months, consumers have become less insulated from those riskier loan decisions, and we are only seeing the tip of the negative equity iceberg."
For its part, while KMX has a large finance division, the company cherry picks the best loans to keep for itself. Weaker loans are sold to the likes of ALLY and others, with no recourse liability to KMX.
Higher interest rates is another risk, as it increases monthly car payments and impacts the buying power of consumers. Credit quality and interest rates are also going to impact financing spreads.
What happens with beleaguered rival Carvana Co. ( CVNA ) will also be worth watching for KMX. Creditors have been circling the company, which played fast and loose with its finances trying to rapidly grow to gain scale. Long term, a CVNA bankruptcy could be good for KMX if it hurts a competitor. However, the company could also come out of bankruptcy stronger and more disciplined, or it may have to liquidate its inventory. The company may also try to stave off bankruptcy. At this point, it's a bit of a wild card, but the industry likely will see some impact.
Valuation
Based on the FY2024 (ending February) EBITDA consensus of $1.0 billion, KMX trades at an EV/EBITDA multiple of about 13x. Based on the FY2025 EBITDA estimate of $1.3 billion, it trades at 10x. I don't include vehicle financing as debt.
On a P/E basis, it trades at 23x the FY24 EPS consensus of $3.02.
It trades at a premium to its peer group , which generally trade with a P.E ratio of between 4-10x.
CarMax, Inc. is projected to see a decline in revenue in FY24 of -6%, followed by a return to growth of 6% in F25.
Conclusion
I think CarMax, Inc. is a tremendous company with a lot of structural advantages working in its favor. Over the long term, I think it has a lot of opportunities to continue to grow and improve margins.
However, while the current used car environment has improved over the first couple of months this year, 2023 is still likely to be a difficult year for the industry against a tough macro backdrop, rising inflation, and higher interest rates. At the same time, CarMax, Inc. stock trades at quite the premium compared to peers.
The bar for the current quarter may be low given the rebound in the used car market to start the year. This could lead to a nice post-earnings rally. However, outside of that, I view CarMax, Inc. stock more as a hold at this point.
For further details see:
CarMax: A Great, But Pricey, Company