CarMax Inc. (KMX, Financial) is one of the leading businesses benefiting from a number of unusually positive trends in the used car industry. Consumer spending with respect to cars is on the rise due to the pent-up demand resulting from the pandemic and, given the high level of pricing and supply shortage of new cars, it is logical for U.S. consumers to buy more used cars.
The company is making the most of this demand. It recently launched a nationwide e-commerce platform for online car shopping and also planned 10 new store openings for 2022, with the objective of continuing to generate double-digit revenue growth. Overall, the company is at an interesting juncture today and merits an in-depth evaluation.
Recent financial performance
CarMax reported a stellar first-quarter 2022 on June 25, surpassing Wall Street's expectations with respect to both revenue and earnings. The company reported a top line of $8.01 billion for the period ended May 31, which implies 128.06% growth as compared to the $3.51 billion in sales reported in the year-ago quarter. The company cruised ahead of the analyst consensus estimate of $6.18 billion as a result of a strong unit sales growth of more than 30%. One key factor driving up revenue was the second round of stimulus payments, though the company did face some inventory issues.
Revenue translated into a gross margin of 14.56% and an operating margin of 7.02%, which was higher than in the same quarter of last year. The company reported net income of $436.76 million and adjusted earnings per share of $2.63, which was as much as $1 above the average Wall Street expectation.
Digital strategy
CarMax has been busy improving its digital platform to show its online capabilities and let customers complete their purchases online. Apart from launching the e-commerce platform, management has added several key performance indicators to help track the success of its new initiatives, such as the number of online appraisals buys, the percentage of used car units sold online and the percentage of revenue coming from online transactions. Their strategy to include more digitally-focused KPIs shows their commitment to the transformation and the confidence they will succeed. Moreover, from the end of the last year, the company has taken two essential steps to increase its revenue, including the roll-out of its instant appraisals tool all over the country and the Edmunds acquisition.
The Edmunds acquisition
CarMax acquired the remaining shares of Edmunds, an automotive research site with a strong foothold in the digital platform. The company announced the transaction in April, valuing the research platform at an enterprise value of $404 million. Management said Edmunds would work with CarMax to streamline their digital purchasing as well as selling capabilities with their strong relationships and services.
The acquisition could mean so much more because Edmunds is a leading platform where potential auto buyers, sellers and window shoppers come to check the availability and further research their options. The Edmunds site also allows millions of customers to peruse until they find a suitable car and finalize that for them before being connected to the dealer. The company has a strong digital presence with more than 300,000 YouTube subscribers and heavy viewership on its car analysis videos. CarMax can leverage the popularity of Edmunds, using their data for lead generation and data analysis. Edmunds is also known to provide auto dealers with tools like inventory listings on their social media site and marketplace, an interactive platform for messaging shoppers, marketing tools to close sales and add-ons including a warranty as well as roadside assistance. With these wide-ranging relationships and services, it becomes possible for CarMax to make the most out of the huge ecosystem of used cars through this acquisition.
Final thoughts
CarMax has been a volatile stock, but has managed to generate a positive return for investors whou bought the stock about six months back. The company is trading at an enterprise value-to-revenue multiple of 1.61 and a price-earnings ratio of 18.96, both of which appear to be reasonable. One of the biggest risks associated with the company is its high debt levels as its debt-to-equity ratio is as high as 3.43. CarMax’s digital offerings and Edmunds should become major growth drivers in the years to come. Overall, the company is a fundamentally strong albeit volatile investment opportunity. I believe that a strategy of buying on dips should work best for this stock.
