CarMax (KMX) Analysis

CarMax is a growth stock and was recommended by businessweek in one of their recent issues. In this segment, we look at CarMax and see if it looks like a good investment.

From its 10-Q, the description of CarMax business is noted below:

CarMax, Inc. ("CarMax" and "the company"), including its wholly owned subsidiaries, is the largest retailer of used cars and light trucks in the United States. CarMax was the first used vehicle retailer to offer a large selection of quality used vehicles at low, "no-haggle" prices using a customer-friendly sales process in an attractive, modern sales facility. CarMax also sells new vehicles under various franchise agreements. CarMax provides its customers with a full range of related services, including the financing of vehicle purchases through its own finance operation, CarMax Auto Finance ("CAF"), and third-party lenders; the sale of extended service plans; and vehicle repair service.

CarMax business is also seasonal. As noted below from its 10-K:

CarMax’s business is seasonal. Most CarMax superstores experience their strongest traffic and sales in the spring and summer fiscal quarters. Sales and gross margins are typically lowest in the fall quarter, which coincides with the new vehicle model-year-changeover period. In the fall quarter, the new model year introductions and discounting on model year closeouts can cause rapid depreciation in used car pricing, particularly for late-model used cars. Seasonal patterns for car buying and selling may vary in different parts of the country, and as CarMax expands geographically, these differences could have an effect on the overall seasonal pattern of the company’s results. In addition, the growth in sales to subprime customers, whose buying activity tends to peak early in the tax refund season, could modestly affect the seasonality.

KMX is a through and through growth story. From its inception in 1996 till to date it has grown revenues and profits consistently. The EPS for the stock declined in 2005 compared to 2004. This is one of the reasons the stock hasnt moved up a lot. Again from 10-K

"We believe the primary driver for future earnings growth will be vehicle unit sales growth from comparable store sales increases and from geographic expansion. We target a roughly similar fixed dollar amount of gross profit per used unit, regardless of retail price. Used unit sales growth is our primary focus. In fiscal 2006, we plan to focus our store growth primarily on adding standard superstores in new mid-sized markets, which we define as those with television viewing audiences between 1 million and 2.5 million people, and satellite fill-in superstores in established markets. We also are broadening our store base in the Los Angeles market, with one additional superstore opened in fiscal 2005 and two additional superstores opened early in fiscal 2006, which gives us a total of five stores in the Los Angeles market. We plan to open used car superstores at a rate of approximately 15% to 20% of our used car superstore base each year. For the foreseeable future, we expect used unit comparable store sales increases to average in the range of 4% to 8%, reflecting the multi-year ramp in sales of newly opened stores as they mature and continued market share gains at stores that have reached base maturity sales levels."

The company also states the projected earnings per share in 2006 in its 10-K.

"We currently expect fiscal 2006 earnings per share in the range of $1.20 to $1.30. We expect CAF income to increase only slightly from the fiscal 2005 level, as projected continuing interest rate increases will likely cause our cost of funds to once again rise more rapidly than consumer rates. Consequently, we expect CAF’s gain spread for fiscal 2006 to be slightly below the normalized range of 3.5% to 4.5%. "

The growth rate is 20% while accomodating the cost associated with the opening of new stores.

Let us take a look at the CarMax balance sheets to see how the company is doing.

On a positive note - the stock holders equity or book value increased by 17% to 800,976 million inspite of the EPS going down on a per share basis from the previous year. The company makes money primarily by selling used cars. Although the compnay does sell new cars, the new cars make a small percentage of the total revenue of Car Max. The company earns 11% of its earnings through financing. The rest of the income comes through the margins for used/new cars. Interestingly enough - the company earns better margins through the sale of used cars than the sale of new cars. The margins are in the 11% and 3% range respectively. If the business week story holds true - one can expect operating earnings growth of 25% per year for the next five years from CarMax.