CarMax Gets in Gear: Is Now the Time to Buy?

Key Points

• CarMax had a solid quarter, outperforming expectations, and is building leverage for investors.
• Cash flow is sufficient to sustain the healthy balance sheet and share repurchases until economic headwinds ease.
• The risk is short interest, capping gains at the top of an established trading range. 

CarMax NYSE: KMX has headwinds in 2204 but is navigating difficult times well, selling more cars than expected and sustaining a solid margin. The company isn’t thriving but is growing and building leverage for when economic headwinds ease.

Between then and now, the company can execute its plans while buying back shares, and the buybacks are significant. Activity in Q3 topped $114 million and reduced the share count by 2.2% year-over-year (YoY). 

CarMax’s share repurchases are expected to continue because of the margin strength in Q3 and the $2.04 billion left under the current authorization. Regarding the business, demand for used cars is solid and is expected to improve as interest rates fall. The only bad news is that the pace of interest rate reduction is less than first indicated by the Fed, and it may take several more quarters for revenue growth to improve significantly. 

CarMax Outperforms in Q3, and Its Share Price Surges Higher

CarMax had a solid quarter in Q3 despite lower realized prices for used cars. The critical details are that demand remains solid, with volume up 5.8% across the network, driven by positive results in all segments, and CEO William Nash says the market is stabilizing. Results from Q3 include $6.22 billion in net sales, up 1.1% compared to last year and 280 basis points better than forecasts. Retail units sold increased by 5.4% and wholesale by 6.3%, offset by a 3.9% and 5.7% decline in average price, respectively. Sales were underpinned by a 7.9% increase in units purchased, aided by a 15% increase in digital channels.

Margin news is the best in the report. The company widened its gross margin despite the decrease in the average selling price by controlling costs. The gross margin gain is partially offset by a 20 basis point increase in SG&A, but only partially. The net result is a 70 basis point improvement in the net margin for a leveraged gain on the bottom line. The $125.4 million in net earnings is up more than 50% compared to last year, leaving the adjusted EPS at $0.81, $0.20 better than MarketBeat’s reported consensus estimate, and up 56% YoY. 

Carmax didn’t give guidance but showed strength and reverted to growth sooner than expected. The analysts' consensus figures for Q4, which predict a seasonal sequential decline but a 3% YoY revenue growth, are likely too low. In this scenario, investors may expect analysts to lift their estimates for the quarter, year, and next year and provide a tailwind for the market. 

Carmax Builds Value for Investors in Q3

Carmax’s Q3 balance sheet highlights show it is building value for investors. The details include a reduction in current assets tied to its cash balance, but total assets are up on increased receivables and property, and long-term debt and total liability are down. The result is a 2.75% increase in equity and low leverage, leaving the business in a solid financial position. The company’s net-debt leverage is only 0.25x equity. 

However, investing in Carmax is not without risks. The short-sellers are interested in this stock and have a reason to be. The used car market is stronger than expected but still struggling, and the impact of lower rates may already be factored into the equation. The short interest rate ahead of the report was over 10%, not remarkably high but high enough to create a headwind for stock prices. 

The price action following the release includes a price surge at the open, but the subsequent activity suggests that short-sellers are taking advantage of the pop. The market is forming a large bearish candle and showing significant resistance at the top of the established trading range. The silver lining is that the market has not fallen below critical support at the short-term moving average and may sustain upward traction over the next few weeks or months.