CarMax’s Growth Turbo-Boosted By Hot Used Car Market (NYSE:KMX)

Timothy
Consumer Price Index Report Reveals March

Chip Somodevilla/Getty Images News

Investment Thesis

CarMax, Inc. (NYSE:KMX) is America’s largest used car retailer, with 220 locations across the U.S. It is also one of the nation’s largest auctioneers of vehicles, with 400,000+ vehicles being sold in wholesale auction format in 2021. However, what separates KMX from even traditional car retailers is holding the largest addressable market in the car industry because of its omnichannel distribution network, allowing consumers to purchase vehicles in person, online, or a mix of the two.

During FY2021 KMX sold over 750,000 vehicles and maintains one of the largest used-vehicle financing arms, with just over 1 million customer accounts amounting to $13.85 billion in receivables. KMX expects to increase this amount of 2 million by 2026, amounting to over 5% of the used US auto market share.

Because of its strategic plan and favorable market conditions, we believe that KMX is an excellent choice for growth capital appreciation.

EPS for FY22 = $6.25

Forward P/E = 20.0

Estimated fair value: $6.25 times 20.0 = $125.

CarMax (KMX)

E2022

E2023

E2024

Price-to-Sales

0.5

0.5

0.5

Price-to-Earnings

13.9

14.0

13.3

EV/EBITDA

18.3

18.4

17.4

Strategic Plan

KMX is focused on 3 key areas: market share growth, total sales growth, and revenue growth.

KMX achieves a 3-3.7% share of the market for 0 to 10-year-old used vehicles. Through increasing market penetration in current areas and geographic expansion, KMX hopes to grow market share by 50% to over 5% in 2025.

KMX wants to double its total unit sales by 2026, presently selling around 1.2 million vehicles a year. Primarily, this growth will come through the investments in digital distribution KMX has made, which management believes will increase CAGR to 10% over the next 5 years.

Finally, revenue growth is key to maintaining growth, with KMX expecting a 75% increase in revenue to 33 billion by 2026 (12% 5-year CAGR). Already, as of 1Q22, KMX has increased its used vehicle sales (excluding wholesale) by 82.6% year over year.

Most of this expansion will come in the form of online growth, in which KMX has already acquired Edmunds, one of the largest online review sites for new and used vehicles. Already, every retail grade vehicle KMX has is listed on their website, with 38% of sales in FY2021 being transferred from their original location to a customer. In FY2021, KMX unveiled its instant appraisal and guaranteed offer system on vehicles. This system provides online customers detailed appraisals and actual offers.

42.5% of KMX retail sales are financed through their CAF, the financing division. CAF has automated the financing application and approval process and gives financing decisions earlier in the sales stage, as customers are more apt to buy when their expectations are set right away. KMX tends to directly lend to buyers with “tier 1 credit” (700+ FICO). However, they are evaluating a broader expansion to include “tier 3” (subprime) buyers (targeting a 10% mix), and a smaller roll out of “tier 2” (between) with an unannounced target mix. Customers that fall outside the current KMX standards are presented with financing options through partners when requesting credit.

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KMX Analyst Day

How the Business Model Works

KMX purchases vehicles and then inspects vehicles to determine undergo quality of the car. Based on its quality and marketability, KMX sends the vehicle to auction or into its retail channel. Less than half of vehicles KMX purchases end up in retail stores, with most going to auction.

KMX acquires 36-41% of its inventory through purchasing used cars directly from consumers (either through direct contact or the new online appraisal program), with the remainder coming from auction, wholesale, fleet vehicles, or other sources. 25 million Americans sell a car annually, and most Americans live within 60 miles of a KMX storefront – allowing ample opportunity for bolstering KMX’s used vehicle inventory.

Customers can choose a vehicle online to test drive for 24 hours (either picking up the vehicle or it being dropped off to their place of work or business).

Once customers decide on a vehicle to purchase, either online or in-person, the vehicle can be picked up, dropped off at the customer’s location, or shipped to them if they purchased it online from a remote KMX location. Once possession of the vehicle is taken, a 30-day money-back guarantee warranty is applied. As previously discussed, 42.5% of KMX retail sales are financed through their CAF financing division. Most of the direct contracts that KMX holds are customers with the best credit, with customers being referred to tier 2 or tier 3 financing through partners if their credit does not meet KMX underwriting standards.

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KMX 10K

Market Conditions

With the semiconductor shortage limiting the production of new vehicles, new car prices have surged and availability is limited. This has spilled over to the used car market and prices have surged 41% year-over-year to February 2022. Unit sales have increased by 15%. New car prices have only surged 13% as a point of comparison.

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Bloomberg

With gas prices also surging, the market for newer fuel-efficient used cars is hot. KMX maintains a large inventory of vehicles, targeting used vehicles between 0-10 years old and a price range of $11,000-37,000 – the remainder go to auction. KMX estimates that there is more than $1 trillion in market opportunity in the used car ecosystem, across all components (parts, data, logistics, titling, retail).

Risk

The primary risk facing KMX is auto supplies. There are currently significant tailwinds pushing consumers toward used vehicles which are driving units, pricing, and yes margin. While we expect these tailwinds to continue over the next year or two, they will eventually come to an end, and pricing and margins will most likely contract.

KMX does internal tier-1 financing and some tier-3 financing. Most risk comes from tier-3 financing, but there is always repayment risk involving any sale done on credit. Consumer credit has an uptick in defaults during a recession. Mitigating that risk is the fact that autos can be repossessed on default, but this in itself is an additional cost and hurts profits.

Conclusion

KMX has a focused strategic plan that has already demonstrated results on track for their FY25 projections. While favorable market conditions won’t last forever, KMX is well positioned to take advantage of the excess cash coming in to meet its targets. We believe that KMX is an excellent choice for growth capital appreciation.

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