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We are reiterating our Neutral recommendation on CarMax Inc. (KMX - Analyst Report). The largest retailer of used vehicles is benefiting from its focus on the used-vehicle market vis-à-vis its peers. However, the company’s margin is under pressure as manufacturers and dealers are providing incentives to attract more customers for trading old cars for new ones.

CarMax, in the second quarter of fiscal 2013 (ended on August 31, 2012), reported a profit of $111.6 million, flat year over year. Earnings of 48 cents per share missed the Zacks Consensus Estimate of 52 cents.

Net sales and operating revenues increased 6.6% year over year to $2.76 billion, surpassing the Zacks Consensus Estimate of $2.74 billion. Used vehicle sales improved 8.8% to $2.2 billion due to higher unit sales. Unit sales went up 8.3% to 111,316 and average selling price marginally increased to $19,494.

CarMax has been performing well with its focus on the used-car market. The company is one of the strongest automotive retailers along with AutoNation Inc. (AN - Analyst Report) and Penske Automotive Group Inc. (PAG - Analyst Report). The company has leading liquidity and profitability ratios among its peer group.

The company is rapidly expanding its stores to meet the increasing demand in the U.S. The company opened 5 superstores during the first half of fiscal 2013 (two in Florida, and the rest in Tennessee, California and Pennsylvania). The company also plans to open 10 superstores during fiscal 2013.

However, weak demand in the new vehicle market, primarily domestic cars, has forced manufacturers to offer incentives and attractive pricing. Incentives on new cars appears more attractive compared to the old ones. As a result, the company has to lower used car pricing to reduce inventory, thereby adversely affecting its margins.

Moreover, the used car market is highly competitive with 37,500 independent dealers. In addition, millions of private individuals are also engaged in the business.

Our Neutral recommendation on the stock is backed by a Zacks #3 Rank, which translates into a short-term (1 to 3 months) Hold rating.

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