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On Nov 28, 2013, we maintained our Neutral recommendation on CarMax Inc. (KMX - Analyst Report) based on its increasing revenues, focus on the used-vehicle market and aggressive store expansion strategy, which offset the negatives.

Why the Reiteration?

CarMax posted a 29.2% increase in earnings per share to 62 cents in the second quarter of fiscal 2014 (ended Aug 31, 2013). Earnings exceeded the Zacks Consensus Estimate by 5 cents.

Net sales and operating revenues in the quarter rose 17.7% to $3.2 billion, beating the Zacks Consensus Estimate of $3.1 billion. The year-over-year improvement can be attributed to improved used vehicle sales, wholesale vehicle sales and higher revenues from extended service plans.

Unlike its peers, CarMax focuses more on the used-car market, which helps it to outperform the industry. Moreover, the company follows an aggressive store growth policy and strong capital deployment strategy, which boost earnings.

During the first half of fiscal 2014, CarMax opened 5 stores, bringing its used car superstore count to 123 as of Aug 31, 2013. The company intends to open 13 stores in fiscal 2014 and 10–15 superstores in both fiscal 2015 and 2016.

However, the used-car market in the U.S. is highly fragmented and competitive. Moreover, incentives on new cars have encouraged consumers to trade in their old cars for new, which has lowered used-car sales and increased the used-car inventory. This is forcing CarMax to lower the prices of vehicles, thereby shrinking margins.

Moreover, higher inventory and decline in accounts receivables and auto loans receivables are resulting in high cash outflow from operating activities. As a result, we maintain our Neutral recommendation on CarMax.

Other Stocks to Consider

CarMax currently carries a Zacks Rank #2 (Buy). Stocks from the broader industry that warrant a look include Pep Boys - Manny, Moe & Jack (PBY - Snapshot Report), U.S. Auto Parts Network, Inc. (PRTS - Snapshot Report) and Lear Corp. (LEA - Snapshot Report). All of them carry a Zacks Rank #2.

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