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On Mar 11, we maintained our Neutral recommendation on CarMax Inc. (KMX - Analyst Report), based on its aggressive store expansion strategy and focus on the used-vehicle market, despite lower margins from used vehicle sales owing to the aggressive incentives offers by manufacturers and dealers.

Why Maintained?

CarMax reported a 13.9% rise in earnings per share to 41 cents in the third quarter of fiscal 2013 ended on Nov 30, 2012 from 36 cents per share in the year-ago quarter. The EPS surpassed the Zacks Consensus Estimate by 2 cents. Profits escalated 15.3% to $94.7 million from $82.1 million in the year-ago quarter.

The company’s net sales and operating revenues for the quarter climbed 15.1% to $2.6 billion from $2.3 billion in the third quarter of fiscal 2012. Revenues also beat the Zacks Consensus Estimate of $2.5 billion.

Following the release of the third quarter results, the Zacks Consensus Estimate for fiscal 2013 increased 0.5% to $1.87 per share. The Zacks Consensus Estimate for fiscal 2014 also went up by the same magnitude to $2.06 per share.

CarMax focuses more on the used-car market, which helps to outgrow its peers. CarMax is one of the strongest operators with leading liquidity and profitability ratios among the other automotive retail companies including Penske Automotive Group Inc. (PAG - Analyst Report) and AutoNation Inc. (AN - Analyst Report).

CarMax undertook aggressive store expansion policy based on the improving sales environment in the U.S. In the first nine months of fiscal 2013, CarMax has opened 8 superstores and plans to open around 10 more superstores in fiscal 2013.

However, we are concerned about the sluggish sales environment for new vehicles particularly for domestic cars. The margins on used vehicle sales were adversely affected by incentives and attractive pricing offered by the manufacturers and dealers for the new cars. High used car inventory is also putting pressure on the prices, thus affecting the margins. In addition, the used-car market in the U.S. is highly fragmented and competitive.

Other Stocks to Look For

O'Reilly Automotive Inc. (ORLY - Analyst Report) is performing well in the industry where CarMax operates. O'Reilly is a Zacks Rank #1 (Strong Buy) stock.

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