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CarMax Stays Neutral

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On Jun 27, we maintained our Neutral recommendation on CarMax Inc. (KMX - Free Report) based on its continuous focus in the used-vehicle market and its aggressive store expansion strategy together with better performance in the first quarter of fiscal 2014. However, we are concerned about lower margins from used vehicle sales owing to the aggressive incentives offered by manufacturers and dealers.

Why the Reiteration?

On Jun 21, CarMax posted a 23.1% increase in earnings per share to 64 cents in the first quarter of fiscal 2014 ended May 31, 2013, from 52 cents a year ago. Reported earnings also exceeded the Zacks Consensus Estimate by 7 cents.

Net sales and operating revenues in the quarter rose 19.3% to $3.3 billion, topping the Zacks Consensus Estimate of $3.1 billion. The year-over-year improvement in revenues was due to increase in used vehicle sales and wholesale vehicle sale.

Following the release of the first quarter results, the Zacks Consensus Estimate for fiscal 2014 increased 3.4% to $2.15 per share. The Zacks Consensus Estimate for fiscal 2015 also went up 3.0% to $2.37 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 other automotive retail companies including Penske Automotive Group Inc. (PAG - Free Report) and AutoNation Inc. (AN - Free Report) .

CarMax undertook aggressive store expansion policy based on the improving sales environment in the U.S. During the first quarter of fiscal 2014, CarMax opened three stores, penetrating the Harrisonburg, Va. market and the Savannah and Columbus markets in Ga. At the end of the quarter, CarMax opened the fifth store in the Houston, Texas. The company also plans to open 10 and 15 superstores in the following two fiscal years.

However, we are concerned about the sluggish sales environment for new vehicles and particularly for domestic cars. Used vehicle sales margins 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 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

Visteon Corp. (VC - Free Report) is performing well in the industry where CarMax operates. Visteon is a Zacks Rank #1 (Strong Buy) stock.

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