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I don't know what the Street explanation for the 10% drop is, I suppose disappointment that there are no signs of earnings recovery so far, but a 10% haircut seems like overdoing it, based on no particularly bad news.

$0.75 eps was compared to last year's Q3 with $0.79, or $118.6m instead of $125.9m.

At a $69 share price, that means that by my calculations, trailing 4 quarters' earnings will be down from $460.8 to $453.5m. With a market cap of $10.9b, that means they are now trading at 24x earnings. So their's still an implicit assumption that they can get things back on the rails and go back to their pre-COVID $850m+ of 4 years ago, not necessarily needing to get back up to the $1b+ they got in COVID years. Their current price represents a 13 multiple on that hoped-for $850m.

Is a 13x multiple on a hoped-for return to profitability levels too low or too high?

Well, on the one hand, the share price 4 years ago, in Feb 2020 when they had made $888m in net income for the previous year, was about $100, based no doubt on the steady gains in revenue and net income over the previous 5 years. It seems that $69 might be a high price to pay for a situation where the company has most certainly NOT been doing very well over the past few years - shouldn't it get a lower multiple based on (a) the $888m is not here today, it's just a hope, and (b) the company can not be said to be growing its earnings as reliably as it seemed, 5 years ago.

On the other hand, we do have 4 more years of growth in hand, not in earnings, granted, but at least in cars sold and in revenue. Revenues for the Feb 2000 year (representing 12 months from Feb 2019 to Feb 2020, i.e. entirely pre-COVID) were $20.3b, and for the most recent 12 months they were $27.0b, 33% higher, so there's that. And if you look at the general market, from Feb 2020, the S&P is up about 32% and KMX is down about 30%. So under the assumption that the company gets back to its earning level of 4 years ago, you're getting it about 50% cheaper now. And with 33% more sales, if the company can regain its 2020 margins and its P/E multiples from then, then you are looking at close to a double, from about $69 to about $133.

I added about 50% more shares to my position at $70, based on the lower price, with nothing substantially wrong with the company's recovery hypothesis, as far as I can tell. I still think the basic model is intact, that being that it is a good company selling an essential product in a slightly better way than its competitors, with a fixed price representing a gross profit of about $2000 per car. And that is in an industry where their 4% market share (3.5% 4 years ago) gives them a long runway for organic growth. I can't really say I see any signs of recovery yet, but no reasons to think they won't get their act together. In the meantime, I am encouraged that they have reactivated their share repurchase plan, which seems like a good use of liquidities while the market plays wait and see.

dtb

I still think the basic model is intact, that being that it is a good company selling an essential product in a slightly better way than its competitors, with a fixed price representing a gross profit of about $2000 per car.


I think you're right that the business model is intact. They continue to execute their plan and deliver the consistent $2200-$2300 gross per unit on the retail side even in a very challenging current environment.

I listened to the call, took a few notes, and I'll share my main takeaways.

Overall the affordability in the used car market for the consumer is really challenged because of price increase and rate increases. No surprise there.

It was interesting to hear them say they saw steep price depreciation in the May-Jul timeframe. The comment on the call was $3,000 of price depreciation during that time and it caused some challenges for them sourcing inventory. I think that makes a lot of sense if you consider they are trying to gross $2,300/unit but trying to balance prices dropping that fast. They are still turning units about every 45 days so their exposure remains very short. They remain operationally excellent there.

What I find interesting is Aug 2023 inventory was $3.8B, down -$830M (-18%) from Aug 2022. If I had to guess I would say their unit inventories are down closer to -25% due to overall higher used car prices holding up the $ inventories. From the comments on the call I think they continue to have a hard time sourcing profitable inventory. They made the comment on the call that overall used auto availability was much worse during the 2008-2011 financial crisis era so that indicates the units are out there but they are not willing to pay up and take the risk, which I like operationally for them. R12 unit sales per store location are down to about 2950, an all time low for all my data back to 2002. Even at these extremely depressed volume levels they are pulling levers to maintain profitability. I still don't see any reason they can't get back to earning $7-$8/share when the car market normalizes and they are selling 4000 units/store, it's just a matter of how long that wait will be.

The comments on the share repurchases did not impress me all that much. They basically said they are going to buy back at a lower pace than they have historically and target to simply offset dilution. That isn't very inspiring compared to their aggressiveness on buy backs historically.

I have not added any yet to my small position. I'm still not certain how long it might be before the car market normalizes. In my day job I can see the products we sell into the consumer space are off over -30% from peak in 2021/22 and still dropping monthly.

Rates need to come down for the lower tier buyer I think before it can be affordable for them. During the call they mentioned the less than $3000/mo income household is off more than 50% for them. There was a time in my childhood where I may have known what that family experience was like but I'm far removed from that today. I can't fathom how a family can live on that level of income today.

Jeff

Rates need to come down for the lower tier buyer I think before it can be affordable for them. During the call they mentioned the less than $3000/mo income household is off more than 50% for them. .... I can't fathom how a family can live on that level of income today.


Yeah, ain't it the truth. How can anyone afford to have a car at all, with that level of income?

On the other hand, for many people, having a job means you have to have a car, and a used car is probably the only car that comes close to being affordable. And it seems odd that Carmax has trouble finding enough cars, but their average price is dropping. What happened to supply and demand? If used cars are tight, shouldn't we expect Carmax to be getting better prices? I don't think they have a 'Costco-like' dedication to fixed margins; in the earnings call, they said, for instance, "As always, we will continue to test price elasticity and monitor the competitive landscape."...


On another note, I noticed from the earnings call that they are now up from 11% to 14% of their sales taking place online, which would mean about 28,000 units sold online, now more than a third of Carvana's online volume, 76,530 in Q2, although it has been higher.) This has to be a good trend for Carmax, in terms of margins. Their average margin on their 200,825 retail cars sold in Q2 was steady, with gross profit per retail unit at $2,251. Considering the much higher margins at online rival Carvana (averaging over $4000, for the last 4 quarters), I would be curious to know how this breaks down between the 14% online and the 86% offline.

And I wonder why Carvana gets margins that are so much higher. They say that Q2 they had "Total gross profit per unit ('GPU') was $6,520, an increase of $3,152"), on 76,530 units sold in their Q2. Of course the 2 companies may calculate this number differently, but I presume it means the price the average difference between their acquisition price and their sales price, before subtracting all their overhead. And of course, with Carmax's size and cost controls, this means that Carmax still ekes out a profit ($696.8 in gross profit becomes $118.6m in net earnings at Carmax; at Carvana it is $396m in gross profit which becomes a $105m loss, and that will just get worse, as their huge debt load matures and sees higher interest rates...)

Regards, DTB (long KMX, short CVNA)

(BTW, the subject line is obviously a mistake: should be Q2, not Q3; their fiscal year starts March 1.)

Any thoughts on the additional decline this week? I dont see any news. Now down 19% in last 1 mo.
I guess KMX is another causalty of rate; is it fair to say that its less related to their own debt/borrowing costs, and more to the impact of higher rates on their customers?

If used cars are tight, shouldn't we expect Carmax to be getting better prices? I don't think they have a 'Costco-like' dedication to fixed margins; in the earnings call, they said, for instance, "As always, we will continue to test price elasticity and monitor the competitive landscape."...

In my opinion, I think they have been at this game a long time and they know how the market cycles. They could try to play the game of the local independent 'sleazy' car dealer and gouge customers in need of a car, but that doesn't build customer loyalty when you're in a commodity business like used cars. If you want a new Ford, you have to go to the Ford dealer. If you want a used Ford, you can go anywhere. Their customer base is the perpetual used car buyer and I think they want to be viewed as the fair price, higher quality location.

If you look back at their gross margins per vehicle for the last 20yrs they are consistently $2k per vehicle. They have come up slightly post pandemic but likely mostly due to general inflation. The used car market is so highly commoditized they can't get too crazy with pricing or they suffer from slower turn. And slow turn kills margins over time with floor plan interest and 'lot rot' depreciation. Post pandemic was a wild time for any and all used items. Used boats and RVs were even appreciating in value at a crazy rate from 2019 to 2022. Now, that game is over. Some lenders are ceasing lending on boats are RVs right now. Not a good time to be sitting on inventory that looked like gold 12 months ago.

Jeff

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