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Down 6% today.
Down 11% last month
Down 55% 1 yr
Heading back towards recent low (55)
20-50% below 5 year average P/E and P/S
Carvana on its way to bankruptcy but Carmax not going away anytime soon
Have we reached peak bearishness?

Down 6% today.
Down 11% last month
Down 55% 1 yr
Heading back towards recent low (55)
20-50% below 5 year average P/E and P/S
Carvana on its way to bankruptcy but Carmax not going away anytime soon
Have we reached peak bearishness?

Congratulations - you are the first Shrewd in Shrewdom to post a message that actually relates to investing, as the others were so stunned to see this platform appear just half a day ago.

I want to respond, alas I have so many Shrewdish technical requests!

So please someone respond to this: provide insights as to whether the quote for Carmax has fallen even more out of line with intrinsic value, or there are genuine changes to revise intrinsic value lower. This is exactly the subject of Falling Knives - investors becoming fearful and allowing an irrational price to get even more irrational for a while.

- Manlobbi

I would think that Carvana's misfortunes would be good news for KMX. We ended up purchasing our last car from Carvana, but had that not been an option probably would have purchased from KMX.

I'll propose (mostly out of ignorance and a desire to learn) that on the other side of the recession KMX will return to pre-recession operations. Maybe a little better if Carvana is out of the picture.

Prove me wrong :)

John

If you scroll down or search on 'carmax' in this thread on the new TMF board:
https://discussion.fool.com/t/1year-berkshire-pric...
then you'll find @cwags02 looking at future forward returns of KMX in relation to P/S values.
His motivation was Jim's analysis of BRK's forward return in relation to binned PBV values, and the thread starts off with @cwags02 take on that.

Have we reached peak bearishness?

I'm thinking not. I'd taken a small position in KMX based on Jim's thoughts along with positive arguments from M*, but I sold a few weeks ago and booked the loss.

My view is that the whole used vehicle market is in for rough times owing to high interest rates and a predatory subprime lending environment that smells much like the one in housing that caused so much damage. Even if KMX as a company is not a direct party to the predation, it seems vulnerable to collateral damage (so to speak). So I'm steering clear.

PS: Hooray for Manlobbi! I'm amazed at how quickly the Shrewdom project went from concept to reality! (But I'm wondering why the website is 'not secure'?)

I believe this price area to be a good start for a three to five year horizon. Their business is essentially a flow business. The more volume throughput at a set margin will increase profit. They are in for a couple of tough quarters, but in the longer term should revert to an upward trajectory in both sales and margins. I am selling atm puts as they fall to build a position. I expect a full position with a basis in the mid sixties will look good in 2026.
Jk

Down 6% today.
Down 11% last month
Down 55% 1 yr
Heading back towards recent low (55)
20-50% below 5 year average P/E and P/S
Carvana on its way to bankruptcy but Carmax not going away anytime soon
Have we reached peak bearishness?


Seems like a good deal to me. Now trading at $61, i.e. market cap of $10.7b

Earnings, last 4 quarters: $807.4m
Earnings, year ending 2022-02-28: $1.151m
Average annual earnings, 3 prior years: $907.3m

In other words, less than 10 times last year's earnings, and less than 12 times earnings for the last 4 quarters. I am going to say that their true baseline earnings level is more like $1b than their recent results, which represent a lot of supply disruption in the used car market, and very high prices. Remember that they make a fairly fixed amount per car sold (typically about $2000), so there's no reason to think that the last few year's profits were anything particularly exceptional.

In the spirit of the Manlobbi method (according to my understanding of it), the first order of business (A) is to ask whether I can be confident of some minimum value of earnings in 10 years. So the questions I would ask myself are, (i) is the business model vulnerable to obsolence or attack by some new model? (ii) Is it in any danger of bankruptcy or insolvency? (iii) Are they vulnerable to what seems like an inevitable recession? (iv) Can I be confident that management is competent and honest, allowing me as a minority shareholder to participate in its possible success in 10 years?

If I can reassure myself about the above (steadfastness), then I will proceed to (B), what kind of growth do I anticipate over the next 10 years, and what is the current multiple of the market cap over the anticipated earnings is 10 years?

So for A(i), I think the business model of buying and selling used cars at a network of dealers is going to be hard to attack. The troubles of Carvana to show any inklings of profitability tend to confirm this. There will be a role for some online transactions, and Carmax is perfectly capable of integrating this into its business and has been doing so (11% of its sales last quarter), but it is hard to see most people wanting to buy a USED car without seeing and driving it first.

(ii) Carmax has $18b in long-term debt, which seems like a lot, but it is because they finance about 40% of the vehicles they sell, and most of this debt is backed up by the collateral which is the cars that are being financed. Only about $3b in true recourse long-term debt, less than 3x earnings.

(iii) I think they are arguably resistant to recession: people need to drive, and if finances are tight, a used car represents better value for money than a new car. Their earnings did not dip notably in the last 2 recessions.

(iv) I see no reason to doubt management's competency or integrity, except perhaps the roughly $100m a year in stock based compensation. This is about 10% of their total earnings (or, to be more precise, about 9% of their pre-SBC earnings, since those earnings are already removed from the GAAP earnings of $1b), but as long as this is 'only' 10%, is disclosed, is not increasing rapidly, and is successful in retaining key employees that would otherwise need to be paid higher monetary salaries, I can live with it. I in particular like their share repurchase activity, which SEEMS to be sensitive to share prices, something you can't say about all companies with big repurchases in place (I'm thinking of Apple, for instance, as opposed to a company like Berkshire where the repurchases stop when prices get higher.) I hope their Q3 results (out next week, Thursday) will confirm this with more buybacks for the quarter that goes up until the end of November.

Going on to B, what kind of growth is it realistic to expect from Carmax? They currently have 4% of the US used car market, and are aiming at 5% by 2025, which seems realistic, and although they are by far the biggest used car company, there is still lots of room for growth. Revenues and net earnings have tripled in the last 9 years, fairly steadily, and although revenue growth may decline a little, I expect profit margins to improve slightly as they grow, benefiting fro scale and network effects, so my guess is they will have tripled their earnings again in 10 years. If in addition to 3 times the earnings, they are back to a more typical 18x P/E ratio, that should provide a nice return from the current $10.7b market cap. The calculations would be: earnings in 10 years: $3b. Multiple in 10 years: 18. IV in 10 years: $54b. Price today: $10.7b. IV10/price: 5.04. Another way of thinking of this is that I am expecting a 404% return in 10 years from the current price ($10.7b, or $61 per share), which annualizes to ... 15.0% per annum (pre-inflation).

I already had about 2% of my portfolio in this but I've taken that to 5% this week.

Regards, DTB

DTB,

Thank you for sharing your detailed analysis.

John

DTB -

Thanks for sharing your thoughts, and for applying the Manlobbi approach. Much appreciated.
I have a 2% position as well, and have been considering doubling it below 60.
Put writing might not be a bad approach, though I might wait for the next set of earnings

2 more points I didn't make that have been trotting through my mind.

1. I wondered whether KMX was or was not vulnerable to an economic slowdown, and guessed that it wasn't very vulnerable. I wondered whether it was maybe even the opposite, able, in other words, to take advantage of a weak economy (or antifragile, to use the term ccined by Nassim Taleb.)

On the one hand, 60% of their clients use financing provided outside of CAF (Carmax Auto Finance.) If banks become unwilling to lend to used car buyers, is this a problem for Carmax?
I don't really know for sure what the answer is, but I suspect the answer is that it is at the 'durable' middle of the spectrum fragile-durable-antifragile.

It is true that Carmax had a big earnings miss last quarter, which many analysts attributed to the beginning of an economic slowdown, but I'm not so sure. The big problem for Carmmax was that there were just no a lot of used cars available for sale, with the same thing true for new cars. If automakers are not producing cars (because of supply chain disruption, lack of chips, lack of labour, etc.), then people will not trade in their used car to buy a new one. High interest rates don't help either. But if there's a slowdown, both of these problems will ease, and I think Carmax's unit sales will bounce back nicely, despite the recession.

I can't find data back far enough to see how their revenue and earnings fared in 2000 and 2008, which would be helpful.

The other major influence on their earnings right now is the recent increase in interest rates. I'm not sure how that one will play out, either. Carmax has the capacity to finance their customers' purchases through its financing arm, and if banks back of from car loans, CAF can potentially take up the slack. Since CAF is a significant part of Carmax's overall earnings, this could potentially end up pushing more Carmax customers towards CAF, and since Carmax has solid finances going into the recession, they probably have the financial capacity to do this.

These are the 2 aspects that I need to read more about, Carmax's past recession performance and its current capacity to expand its role in financing its customers' purchases.

I can't find data back far enough to see how their revenue and earnings fared in 2000 and 2008, which would be helpful.

According to Value Line EPS for 2008 were 27' compared to 89' for 2007.
Net profit margin contracted to 0.8% in 2008 compared to 2.2% the previous year.

Based on forward looking earnings estimates KMX is currently within it's normal valuation range.
The stock price has plummeted, but so have earnings. On this basis it doesn't seem particularly undervalued.

Whether now is a good buying opportunity depends on when and how soon earnings are expected to recover.
Referencing analyst's expectations, earnings are predicted to grow'starting next year'at about 7% for
the foreseeable future.

According to Value Line EPS for 2008 were 27' compared to 89' for 2007.
Net profit margin contracted to 0.8% in 2008 compared to 2.2% the previous year.


Thanks. Any company that made positive earnings in 2008 probably deserves to be called 'durable'.


Based on forward looking earnings estimates KMX is currently within it's normal valuation range.
The stock price has plummeted, but so have earnings. On this basis it doesn't seem particularly undervalued.

If they're at a normal valuation range compared to abnormally depressed earnings, that sounds like a deal. The question is, are their earnings down because of supply chains, a dearth of used cars and high interest rates, or is there something permanently wrong with the company? I suspect it's the former, so now may be a good time to be a buyer.

dtb

Possibly relevant to KMX.

JPMorgan projects used car prices likely to drop 20% in 2023.
If correct that would be good news for KMX, as I assume there would be an accompanying increase in used car sales.

https://www.jpmorgan.com/insights/research/when-wi...

Carmax reports. 'We believe vehicle affordability challenges continued to impact our third quarter unit sales performance, as headwinds remain due to widespread inflationary pressures, climbing interest rates, and low consumer confidence.'

Perhaps this is about as bad as it gets. But I see no compelling reason to open a position right now.

Carmax reports. 'We believe vehicle affordability challenges continued to impact our third quarter unit sales performance, as headwinds remain due to widespread inflationary pressures, climbing interest rates, and low consumer confidence.'


Yes, this window was open on my desktop when I saw the downwards spike in the share quote this morning:

Shortage of used vehicles drags on CarMax profit
https://www.reuters.com/article/us-carmax-results-...

That article was September 20, for Q2, so 3 short months later, for Q3, it's much the same story.

I'm sorry I was tied up with work this morning, or I would have posted something positive, before/during/after buying another 25% at about $51 before markets opened, since I thought and think the badness of the news is distinctly underwhelming. Shares are now back up to $56 or so, so I guess the market is coming around to my way of thinking.

Which is that, OK, used cars are hard to find, interest rates are high, so sales are down (24%, year over year) and earnings are de minimis (24c per share, down from $1.63 Q3 last year). But this too shall pass. In the meantime, the company has strong finances, and despite the awful revenue figure, they still eked out a small profit. I'm not delighted that they have suspended share repurchases as they save cash, at just the moment when a rational buyer should be buying, and they only bought back 30,000 shares (there are now 158.02, down from 158.05 million last quarter). In retrospect, that's probably better, since the share price is lower now, and I can compensate for the lack of repurchases by buying more myself.

Sorry to contradict but I think the price, even at $56, is pretty compelling. They are at just under 16 times their earnings for the last 4 quarters ($3.58), and while the next few quarters might be similarly awful, the business is sound and will recover as soon as the economy normalizes. I would say that if you liked them at $60 yesterday, they are an even better deal today at $56. Of course, that doesn't mean you might not get an even better price, especially if the general economic slowdown drags on long enough, but I think they are at a good price for a more than satisfactory long term return.

DTB

By the way, housekeeping, how do you type text into a text box and do formating that way? Using html code (like < i > without the spaces) still works, but I've heard people mentioning some improvement that I'm not seeing?

And speaking of the site, what is shrewdom meant to mean, anyways? Is it something about shrews (an old-fashioned word for a nagging, disagreeable person, generally of the fair sex) or is it about being 'shrewd'? Or something else?

And speaking of the site, what is shrewdom meant to mean, anyways? Is it something about shrews (an old-fashioned word for a nagging, disagreeable person, generally of the fair sex) or is it about being 'shrewd'? Or something else?

The Taming of the Shrew 'William Shakespeare
'O this learning, what a thing it is!'
Gremio (Act 1, Scene 2)

The range of price targets for KMX is amazing. I have rarely seen such disparity.

Morningstar  $141 (previous target $155)
Baird        $65 ($82)
Evercore     $60 ($64)
Stephens     $53 ($64)
CFRA         $50 ($75)
BofA         $49 ($100)

Most Wall St. research outfits have Price Targets (PT) and not Intrinsic Value(IV). Usually, PT is the price they expect the stock to reach in the next 12 months, though the period may be even shorter.

Morningstar seems to be the exception, where they are estimating IV, and looking at FY 2026 revenue. Other analysts rarely look beyond current or next FY.

We are lowering our fair value estimate to $141 per share from $155. The change is mostly from
lowering our fiscal 2023 and 2024 profit and revenue projections, which have proved too optimistic,
given the affordability problems consumers have today with buying used vehicles. We also increased
our tax rate assumption to 24.5% from 23%, based on where the firm's current tax is trending, and
slightly lowered our long-term profit growth assumption. Total revenue across fiscal 2023-27 is now
7.4% lower than our prior valuation at $162.7 billion.
In April 2022, management announced a fiscal 2026 revenue target of $33 billion-$45 billion. We model
fiscal 2026 sales of $33.8 billion, down from about $36.6 billion previously. Revenue should face
headwinds into fiscal 2024 as used-vehicle prices, though falling from recent levels...

At the moment KMX sitting above 60, fully retracing yesterday's plunge.
DTB - Nice call. I guess the market agrees with you.
Alas - I was busy with work and missed the opportunity to add in the early market. One needs to be decisive and quick to take advantage of some of these opportunities when they present themselves

My view is that the whole used vehicle market is in for rough times owing to high interest rates and a predatory subprime lending environment that smells much like the one in housing that caused so much damage. Even if KMX as a company is not a direct party to the predation, it seems vulnerable to collateral damage (so to speak). So I'm steering clear.

With a 25 year old trying to replace his very old car and seeing 17% interest on a 'new' old car loan, I understand this sentiment. It could be tempting to try to buy an actual new car with the significantly lower loan rates and lower ongoing repair needs, though that would require the maturity to get a car he can afford to get him to work and back, rather than one that suits his off work needs and wants. And of course, insurance will skyrocket on a new car vs a car that doesn't require collision insurance. Don't know that will happen. (Luckily for Youngest, Bank Of Mom and Dad will float him a loan at the going rate of a 5 year CD/Treasury, which has the result of his getting a more reliable car while requiring responsibility without extorsion rates.)

With article after article on car manufacturers limiting or discontinuing the more affordable models of their cars, focusing on the more profitable, there may become an increasing desire to buy gently used cars as the new car affordability decreases. This would bode well for KMX. New car manufacturers and dealers like the low inventory triggered by chip shortages, noting that they are more profitable selling fewer cars at higher prices, carrying less overhead that periodically needs to be discounted to sell. Will they continue the reduced inventory strategy when chips are not an issue? https://www.kbb.com/car-news/automakers-plan-to-bu... If so, this will increase at least short term demand for used cars, though long term supply issues, so is that a plus or a minus for KMX?

And regarding that predatory lending, which is secured by the vehicle, if those vehicles decline in value by 20% as has been suggested in a previous post, how many will simply walk away from that car payment, just as people walked away from their mortgages when their homes went underwater in value? Surely that will have to impact KMX, if only in the value of the collateral for the loans they issue.

FWIW,

IP

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