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Used-car dealers enjoy much higher margins than new-car dealers. That’s why I prefer those stocks, since those margins can run at 11% or more compared to new-car dealers, which have 1% to 2% margins.
CarMax (NYSE: KMX) came in with first-quarter earnings that demonstrate this fact. The company delivered earnings per share of $0.86, up 13% from $0.76 last year. However, I ignore EPS when share buybacks are in place, because they can trick you about organic growth. Look instead to net income, which was $182 million, up 7.2% from last year’s $169.7 million.
This is decent – but not great. What’s going on with CarMax?
Revenues increased 7.1% year over year to $4.01 billion. Used-car revenues leapt 7.6% to $3.29 billion, the result of a 9.29% increase in volume. That was kicked by a 1.6% fall in average selling price. Alas, in the previous quarter, we saw volume rise by double-digits.
While we saw comps rise 4.9%, it was not the 6.9% of last quarter. Mid-single digits is fine in a so-so economy, but I don’t like the quarter to quarter decline.
Here’s a minor problem: new-vehicle sales fell 14% on a 14.7% decline in volume, even though the average selling price increased 0.9%. To give you an idea of perspective, used-vehicle volume accounts for 98.5% of used and new CarMax sales.
Wholesale vehicle sales increased 5.79% to $577 million on a volume increase of 4.7%. Wholesale does about 60% of the volume of used sales.
Extended protection plan revenues are very high margin, and I like that they increased about 12.5% to $72 million.
This all led to an 8.4% increase in gross profit, to $544 million.
Financing Is the Thing
Financing is where it’s at for CarMax. It has 89% gross margins, but it’s a tricky undertaking. The company must underwrite conservatively enough to make losses low, but open enough that it can enjoy interest rates reflective of risk. This segment delivered 15.3% growth and income of $109 million.
Obviously, the more CarMax can sell those protection plans and keep that financing balance, the better. The company generated $1.36 billion in loans during the quarter, and now holds about $8.66 billion in receivables. It’s a massive business and provides a solid backstop as far as liquidity if the company is ever in trouble.
CarMax needs to trim expenses. There’s about $30 million worth of stuff to cut in compensation and overhead.
I don’t mind the buybacks. I think that’s a fine use of cash as it makes each share worth more. I just want to remind investors that the buybacks are what gooses the EPS number, and it’s net income that matters.
CarMax is in fine financial shape, with its $352 million in cash. Although the debt is $9.5 billion, most of it is just funneled into the $8.6 billion of finance receivables it has.
The CarMax earnings report reveals a company that’s doing well. It just isn’t going gangbusters, and its price-earnings ratio of 25 is way too high for a company only growing net income 7.2%. I can’t consider buying it unless net income growth is at least twice that, if not more.
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