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Bull of the Day: CarMax (KMX)

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The market for new cars is booming. The market for used cars is absolutely exploding! You’ve probably heard this already, but you may not know how best to invest to capitalize on it.

Thanks to a number of supply factors – primarily caused by the Covid-19 epidemic – consumers are desperate to get cars and are having a hard time finding what they want. When they do, they’ve become accustomed to paying premium prices - and that’s translating to rising revenues and earnings at firms that trade in passenger vehicles.

With over 220 locations nationwide, CarMax (KMX - Free Report) is the largest US retailer of used autos, selling 1.2 million units in FY 2021 and bringing in $19 billion in revenue. In the most recent quarter (fiscal Q1 2022), CarMax brought in $7.7 billion in revenue – up 43% sequentially and 143% YoY. In addition to increased unit sales and revenue/unit, CarMax also saw a better than 10% increase in profit per unit sold.

Do you like when revenues and margins increase at the same time? Who doesn't?

Diluted net earnings of $2.63/share in the quarter were up 65% over the year-ago period. Rising analyst estimates going forward earn CarMax a Zacks Rank #1 (Strong Buy).

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With the ability to do huge sales volumes compared to smaller competitors, CarMax is currently the beneficiary of economies of scale in a way that that promises to keep that party going. In a business in which success is defined by the spread between the price at which a dealer can acquire a car and how much they can sell it for (as well as how quickly), the ability to acquire and turn over inventory is hugely important.

Last quarter, thanks to an efficient system of online instant appraisals, CarMax took in 341K used vehicles, a 236% increase. The company adapted to a marketplace in which many consumers might be wary of buying and selling cars in person. CarMax used its considerable technological advantage to grab a big chunk of market share.

When you see market conditions suddenly turn in the favor of a given industry, it’s a tried-and-true investment strategy to find the best company – the” best of breed” – and push your chips in.

Investing can often be difficult, but having a tailwind makes it so much easier.

CarMax is definitely the best candidate in the industry. Newcomer Carvana (CVNA - Free Report) gets more press than CarMax, thanks in no small part to clever advertising and those very visible car “vending machines” that make it seem as though buying or selling a car at their locations is as easy as buying a candy bar or a bag of chips.

I have to admit that’s a great strategy for getting attention, but they're also a long way from producing real profits for investors. Carvana has a $56 billion market cap and the Zacks Consensus Earnings Estimate for the current year is a net loss of ($1.59)/share. Revenues are expected to total $9.9B.

In contrast, CarMax is expected to take in two and a half times as much in revenue - $24.7 billion - and earn $6.62 dollars/share in net earnings. Their market cap is less than $22 billion. At the current share price, CarMax has a forward 12-month P/E Ratio of 20.3X – even less than the S&P 500 at roughly 23X.

If you know that the auto market is hot – and you prefer the steak to the sizzle – the best choice is obvious, and it’s CarMax.


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