EUR 850.00 For Business Accounts Only

Morningstar | CarMax's 3Q Gets Help From Tax Change, but We See Company as Still in Good Shape

We are not changing our fair value estimate for CarMax after incorporating fiscal 2019 third-quarter results into our model because we see no change to our investment thesis. Diluted EPS rose 34.6% year over year to $1.09, beating consensus of $1. We calculate 15.3% EPS growth excluding the impact of the U.S. tax law change. Revenue rose 4.6% to $4.3 billion, about in line with consensus. We are glad to see the market on Dec. 21 looking past the admittedly weak same-store unit sales growth of negative 1.2%. CarMax had a tough comparable with the fiscal 2018 third quarter because six Houston area stores had a very strong quarter a year ago as people replaced vehicles lost in Hurricane Harvey. It reported that excluding these six stores, same-store comparable unit growth was 2.3%. This adjusted metric is still below the upper single digits where the company needs it to be for SG&A leverage, but management did report a higher conversion rate on lower store traffic and SG&A as a percentage of revenue fell 20 basis points.

With interest rates rising, uncertainty in the strength of consumers' 2019 tax refunds, and some temporary cost inefficiencies as CarMax rolls out its omnichannel initiative in Atlanta, results may be choppy for the next few quarters. Still, we see the business as in good shape, and the fact that CarMax can increase EPS and improve third-quarter adjusted free cash flow, by our calculation to $72.4 million from negative $163.1 million in the prior-year quarter, shows the resiliency of the business. CarMax Auto Finance continued its growth path as well, with the finance arm growing income 6.7% to $109.7 million on an 8.4% increase in average managed receivables and a stable loan-loss allowance of 1.12% of managed receivables. We expect continued pressure on CAF's interest margin, which fell 10 basis points to 5.6%, but the unit has consistently offset this pressure with volume growth, and we expect that trend to continue.

CarMax recently announced the first major rollout of its omnichannel strategy, which expands its digital offerings to complement the firm's 200 brick-and-mortar stores and enable customers to complete transactions on their terms at home or in store. CarMax will deliver the vehicle to a customer's home or office for a test drive, and financing, appraisal, and other paperwork can be online. Customers can also use a new express pickup option that allows the process to be mostly done online before coming in and then the purchase finishes in the store in 30 minutes. CarMax expects the majority of its customers nationwide to have omnichannel available by February 2020.

We think this change and incremental spending is exactly what CarMax should be doing as it needs to adapt its business model to online shopping to best compete with franchise dealers such as Penske Automotive Group and AutoNation, which have started their own stand-alone used-vehicle stores, as well as to compete with startups such as Carvana and Shift, which are becoming more well capitalized by having gone public or receiving capital from dealerships we cover, such as Lithia and AutoNation.