In this article, let's take a look at CarMax Inc. (KMX, Financial),a $11.69 billion market cap company, which is the largest U.S. retailer of used vehicles. It owns and operates more than130 used car superstores in about 60 markets and sells new vehicles at five locations.
Successful “No-Haggle Pricing”
The company was the first to offer higher quality used vehicles with a no-haggle pricing strategy across its stores. These competitive low prices cannot be imitated by its rivals who failed because their salesforces are focused only on selling vehicles.
The auto retailer offers several advantages to attract customers that are somewhat dissatisfied with traditional auto retailers. Starting by low, no haggle prices, to good quality vehicles, the company gained a strong position. Also, a customer-friendly sales process contributes to this objective.
With a different model than the rest of the retailers, the company selects its people from other industries. Additionally, they gain the same commission no matter which vehicle the customer buys. The process begins and ends with the same sale-person and customers feel more attracted than going to a finance department. This generates customer satisfaction, which they valued it a lot.
Growth Driver
A growth driver for the firm is that it has a renewed company. Almost one of four of its used-vehicle stores are less than five years old. It is a time frame that equals the timing when costumers are buying a car.
The information systems are very important for CarMax, which has designed its own dealer management system software long time ago.
Pricing Policy
The management believes that it is better to reduce prices rather than increase margins. So any improvement in operating expenses would go to benefit the clients. Further, the pricing policy helps to keep away competitors.
Revenues, Margins and Profitability
Looking at profitability,revenue growth by 13.14% led earnings per share increased in the most recent quarter compared to the samequarter a year ago ($0.76vs $0.64).During the past fiscal year, the company increased its bottom line. It earned $2.17 versus $1.87 in the prior year. This year, Wall Street expects an improvement inearnings ($2.55 versus $2.17).
Finally, let´s compare the best measure of performance for a firm's management: the return on equity. The ROE is useful for comparing the profitability of a company to that of other firms in the same industry.
| Ticker | Company | ROE (%) |
| KMX | CarMax | 14.85 |
| LAAN | Auto Nation Inc | 18.18 |
| CST | CST Brands Inc | 22.17 |
| LAD | Lithia Motors Inc | 19.82 |
| AZO | AutoZone | 14.75 |
| Ă‚ | Industry Median | 9.8 |
The company has a current ROE of 14.85% which is higher than the industry median. In general, analysts consider ROE ratios in the 15-20% range as representing attractive levels for investment. So for investors looking those levels or more, AutoNation (AN, Financial), CST Brands (CST, Financial), Lithia Motors (LAD, Financial) and AutoZone (AZO, Financial) could be the options. It is very important to understand this metric before investing and it is important to look at the trend in ROE over time.
Relative Valuation
In terms of valuation, the stock sells at a trailing P/E of23.5x, trading at a premium compared to an average of 16.9x for the industry. To use another metric, its price-to-book ratio of 3.5x indicates a premiumversus the industry average of 1.57x while the price-to-sales ratio of 0.9x is above the industry average of 0.69x.
As we can see in the next chart, the stock price has an upward trend in the five-year period. If you had invested $10.000 five years ago, today you could have $29.907, which represents a24.5% compound annual growth rate (CAGR).
Final Comment
CarMax operates in a cyclical industry, where customers can postpone their decision to change the vehicle in a scenario of recession. But even if we are not in a recessionary environment, demand for used vehiclescould be weaker than it is expected.We have to remember that used cars account for over 80% of revenue.
As outlined in the article, the management focuses on creating long-term value. Further, there are plans to add stores in new markets and we believe CarMax has a good opportunity to grow even more.
Hedge fund gurus like Bill Frels (Trades, Portfolio), Chuck Akre (Trades, Portfolio), Chris David and Ron Baron (Trades, Portfolio) added this stock to their portfolios in the second quarter of 2014.
Disclosure: Omar Venerio holds no position in any stocks mentioned
