CarMax

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 3/5

CarMax is the largest used car retailer in the US, operating through a combination of retail and wholesale channels, as well as having a growing presence in the online market.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

CarMax operates primarily in two segments:

  1. CarMax Sales Operations (Retail): This segment involves the sale of used vehicles to consumers through its physical stores and online platform. It also generates revenue from selling extended protection plans (EPP) and other third-party finance and insurance offerings. This segment is responsible for most of its revenues and focuses on a customer-centric approach to selling vehicles.
  2. CarMax Auto Finance (CAF): This segment finances a portion of CarMax’s retail sales of used vehicles. CAF also generates revenue through fees and interest income from these loans.
  • Used Car Market Growth: The used car market is relatively large and growing. The pandemic led to a surge in demand for used cars due to supply chain disruptions affecting new car production. As these supply chain issues abate, there are concerns of potentially declining used car sales as people can finally buy new ones.
  • Shift to Online Sales: As seen with other retailers, consumers increasingly prefer online shopping and the ease that it provides. Companies are needing to adapt and invest in this transition.
  • Inventory Management: Dealers are dealing with a challenging inventory environment given the effects of supply chain issues and fluctuations in consumer spending. Therefore, better inventory management is key for dealers to maintain good margins.

Competitive Landscape

CarMax has significant scale in the used car market, and there are several competitors, but it is hard for a competitor to completely replicate it’s nationwide reach. Competitors include smaller regional used car dealers and national new car dealerships that also sell used cars. Given that CarMax is often more expensive than it’s competitors, the company does not compete effectively solely on price, rather it competes on customer experience. The key challenge for CarMax lies in convincing customers to pay higher prices than competitors due to a perceived superior customer experience.

Financials

CarMax’s latest report is the 10-Q for the period ending May 31, 2024. Recent Concerns: KMX missed earnings expectations for the 1st quarter of fiscal year 2025 by a considerable margin and lowered guidance due to a variety of reasons. These include soft traffic and macro conditions, as well as increased financing costs, among other reasons.

Revenues: Total revenues for the three months ended May 31, 2024, decreased by 7.5% year-over-year to $7.11 billion. The decrease in used unit sales was 5.4%. Total revenues for the first 6 months of fiscal year 2025 also decreased, by 1.4%, to $14.1 billion. Gross Profit: Gross profit decreased by 8.2% in the first quarter year over year, and by 1.4% in the first six months year-over-year. It should be noted that gross profit per used retail vehicle has fallen 4.3% in the 1st quarter year-over-year. CAF Income: Income from CAF declined 17.7% year-over-year in the first quarter and 15% year-over-year in the first 6 months. This shows the current headwinds faced by the finance department. Net Earnings: Net earnings totaled $144.9 million, or $.95 per share for the first quarter. Margins: Gross profit margins decreased from 11.5% to 11.1% during the same period. Cash: cash and equivalents totaled $335 million. Debt: Debt totaled $1.9 billion. Total liabilities came to $21.1 billion.

Moat Rating

Rating: 3/5

  • Brand: CarMax has successfully established a well known national brand for used cars, giving it a strong level of recognition. This provides a certain level of trust and credibility to consumers that other players may lack. However, this is not a brand based on brand exclusivity (like Coke or Apple), rather based on brand reputation for a standardized process and large selection of vehicles. Therefore, competitors can replicate this to some degree, thus not providing a wide moat.
  • Scale Advantage: CarMax is a very large company and the largest used car dealer in the US, therefore they are able to gain scale in procuring vehicles, as well as more cost effective financing through CAF. In addition, it has scale in its marketing and advertising, as those costs are spread across a large number of vehicles.
  • Proprietary Data & Processes: The core aspect of CarMax’s moat comes from its unique way of selling used cars, the company’s integrated technology platform, and its deep data. It is constantly upgrading its processes based on the data it collects, and how customers react to new initiatives. In addition, it leverages technology to allow customers to shop for a vehicle and get finance approvals on their phones, giving it an edge. These proprietary factors create some form of competitive advantage.
  • Switching costs: It should be noted that there are not many switching costs when going with CarMax or a competitor, though the seamlessness of its experience can give it a small moat.

Taken together, these factors lead to a narrow moat rating, a company that can maintain returns for the foreseeable future, but perhaps not for as long as a wide moat company.

Risks to the Moat and Business Resilience

  • Increased Competition: Competition will lead to pricing pressure and reduce margins if CarMax’s advantages are eroded over time. This might lead to decreased revenue per unit of the company.
  • Economic Downturn: A weakening economy will dampen consumer spending and lead to reduced demand for used vehicles. Because the demand for durable goods is correlated to the economy, these companies may face tough headwinds due to changes in economic condition.
  • Changes in Consumer Preferences: A shift in consumer buying habits, for example, preferring the benefits of new cars or a different approach for buying used cars, will hurt the business. This includes potentially a preference to purchase EVs rather than gas-powered vehicles.
  • Disruptive technologies: CarMax’s moat is highly dependent on the number of dealerships that it has in the country, as well as a smooth online buying process. However, technological advancements may diminish the value of these moats, potentially as a completely online auto dealer may come into existence, or even augmented reality buying experiences making physical dealerships obsolete.

The business is somewhat resilient in the sense that it is relatively profitable and has a strong national presence. However, given the high competition in this sector and cyclical nature, KMX is vulnerable to downturns as well as erosion in its moat.

Understandability Rating

Rating: 2/5

CarMax’s business model is generally simple to understand. However, determining if the business is creating a sustainable competitive advantage for itself and projecting its long term profitability is tough. The complexity of assessing the value of goodwill and acquired intangibles and correctly classifying financing activities also increase the complexity of understanding the business. It requires a good understanding of a company’s complete financial picture.

Balance Sheet Health

Rating: 3/5

While CarMax has a manageable level of debt and decent amount of assets, it is still susceptible to the market environment. The increase in leverage and the decline in profitability mean that its financial health is weakening. Therefore a score of 3 is appropriate.

Conclusion

KMX is in the used auto retail industry and has been able to carve out its niche using a variety of methods, such as its size, brand, technology, and processes. The company has a decent moat that should provide it with an advantage for the next several years. However, it should continue to invest in its technology, brand and processes to ensure it continues to remain a player in the used auto industry.