The largest used car retailer Carmax (KMX) beat analysts expectations by improving profit margins on autos during this difficult time. As everyone is well aware, new car sales have plunged over the last year forcing two of the “big three” U.S. automakers into bankruptcy and crippling the many suppliers that support those businesses. The same struggles have effected Carmax’s sales as they are down 17% year over year, but the used car industry has been somewhat insulated from the cyclical downturn in new auto sales.
Carmax wisely saw difficult times were ahead and slashed costs to the bare minimum as we related in our post in early April Carmax Profits by Keeping Costs Low. The company cut employment and drastically reduced capital expenditures by nearly 90%. This has helped improve margins on each car sold as gross margins improved to 15.1% from 12.8%. Gross profits per used car surged to $2001 from $1742. This vast improvement margins allowed the company to keep EPS flat at about 13 cents even though sales have fallen off.
Shares have surged ahead more than 15% on Friday, as the company’s cost management has been very impressive in this downturn. Foot traffic in their showrooms is down significantly and Carmax is not able to finance as many cars as in the past, so that source of revenue has shrunk as well. The fact that they were able to keep earnings up in this sort of environment is indeed impressive. However, after the run up in shares today, this stock is not one that we would recommend at this time. It is likely that sales may continue to struggle for the next quarter or two, and we would expect new car dealerships to compete extremely aggressively for auto buyers’ business. The company has deeply cut costs and there may not be much more fat left to trim.
Given the current sales environment and today’s 15% run up in shares it is hard to argue that the stock is particularly cheap right now. According to a consensus of Wall Street analysts the company is expected to earn $.27 this year, the most bullish analysts is calling for $.57 cents. It could be assumed that splitting the difference in these two numbers ($.42) would be considered a successful year for the company. That would brink the P/E ratio to somewhere around 35, clearly that is quite a premium in this market. All things considered, the company has performed admirable given the difficult environment, but we are reaffirming our Fairly Valued valuation at this time.