CarMax (KMX) operates a national chain of more than 200 used car superstores. It focuses on the upper end of the used market, vehicles less than six years old, typically with only one previous owner, notes Doug Gerlach, editor of Investor Advisory Service.
Last year, CarMax sold over 750,000 cars to retail customers and wholesaled another 450,000. Trailing 12- month revenue was more than $20 billion. Uncertain economic conditions are a risk, but disruptions will probably hurt competitors much more than CarMax.
With shares down by almost half from recent all-time highs, we see an opportunity to buy a growing market leader at a discount price.
The reputation of the used car business will repel some investors. We’re not in love with the industry either, but it does have some very attractive features. It is big, and while somewhat cyclical, it sells a necessary product. Almost everybody needs a car.
We view CarMax as an undisputed leader in its market. The company has an increasingly recognizable brand, and its future growth prospects are highly visible as it colonizes more of the country.
The company has been a little slow to respond to a push from online-only competitors. Its e-commerce initiatives are steadily improving, however, and CarMax looks like the long-term leader.
Like all car dealers, CarMax makes a considerable portion of its overall net income from arranging financing for customers. In a sudden economic downturn like the one we are currently entering, the company may struggle to place its collateralized securities, even at rates that pass most of the borrower interest along to investors. That means financing income is likely to plummet until capital markets stabilize.
There will be some incremental stress on the balance sheet, but we think the company is going into this downturn on very solid financial footing. 2020 will be a difficult year, but our forecast for 9% EPS growth assumes that the company remains profitable and returns to growth in 2021 and beyond.
A P/E of 20, combined with potential high EPS of $7.94 generates a high price of $159. We are using $44 as a low price. On that basis, the upside/downside ratio is 9.4 to 1.
