Paradox: An apparent contradiction that nonetheless proves to be true.
2020 has been an unusual year, to say the least. Ordinary life has been turned upside-down by the spread of the Coronavirus and subsequent business closures and stay-at-home orders.
One of the most interesting aspects of this year has been that some businesses that a reasonable person might have expected to suffer in this situation are actually doing quite well. As investors, we can often earn our best returns on the “paradox” trades – buying the shares of companies that seem like they should be performing poorly, but are growing earnings instead.
The used car industry is one of those opportunities. For context, let’s look back to the last major economic shock in the US.
Vehicle sales in the US took a major hit during the great recession of 2008-2009. When times are lean, consumers tend to stretch the useful life of their autos further, making repairs and living with older models instead of committing a big portion of already stretched budgets to newer upgraded vehicles.
In general, when economic conditions improve, new and used vehicle sales increase at about the same rate. Over the past 8 years however, that hasn’t been the case. Used car sales have been outpacing new, especially as the price difference between the categories grows.
In 2013, the average price difference between new and 3-year old vehicles was 56%. That number swelled to 62% - or about $14,000 – by 2019. That difference helped fuel record used car sales of 41 million in 2019.
America’s Car Mart (CMRT) operates 150 dealerships in 12 states, primarily in smaller cities through the Midwest and Southeast. Their direct competition tends to be independent “mom and pop” used car lots that struggle to match the variety of inventory and range of services made possible by greater scale.
CRMT is the big fish in the small pond.
That local presence, high levels of customer service and an increasingly loyal customer base has led to significant increases in top line sales – averaging almost 15%/year. Sales for the first three quarters of 2020 were $172M – 19% higher than the same period in 2019.
Selling cars is only part of the picture however, as America’s Car Mart specializes in offering customer financing, often offering low down payments and payment plans with bi-weekly options.
In the most recent quarter, the average customer sales price increased by 15.3% alongside a $4.1 million increase in interest income collected. Their average vehicle is financed for 32 months at an annual interest rate of 16.5%.
In a low interest rate environment in which US Treasury Bonds with 10 years to maturity yield lower than 1%/year, 16.5% is a truly outstanding figure for loans with less than 3 years remaining.
You might surmise that many customers must have less-than-perfect credit - and you’d be correct – but the high interest rates don’t translate into high losses in the finance division. In fact, America’s Car Mart has been significantly shrinking charge-offs lately, thanks to the rapid new car depreciation figures.
The difference is in the value of the collateral for those auto loans.
The company is selling vehicles that already depreciated significantly over the first few years in service. That translates into a shallower depreciation curve later in the autos’ usable life and an increased chance that in the event America’s Car Mart will recover most or all of their investment in the event that they are forced to repossess a vehicle for non-payment.
America’s Car Mart has been consistently beating analyst estimates over the past several years and the shares have been rallying, yet remain an extremely reasonable on a Price to Earnings basis. Like the rest of the market, CRMT shares took a beating in March and April and have recovered significantly. They haven’t quite reached the 2019 highs yet however – and that may be the opportunity.
With a 12 month forward P/E Ratio of just 10.7X, CRMT is significantly cheaper than the S&P 500 at 28X and its own industry at 15X.
Several recent upwards earnings revisions earn the company a Zacks rank #1 (Strong Buy).
With a competitive advantage in the markets in which it participates and a unique niche in the finance business, America’s Car Mart represents one-stop shopping for its customers as well as investors in the auto-sales industry.
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