CarMax Q4 2022 Earnings Preview: A Favorable Risk To Reward Prospect (NYSE:KMX)

Prices Of Gas And Consumer Goods Rise As Inflation Hits 40-Year High

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When it comes to the automotive retail space, one of the big players in the industry is CarMax (NYSE:KMX). With a special focus on selling used vehicles, as well as a thriving financing arm, the company has done well to create value for its investors over the long haul. Despite experiencing a bit of pain during its 2021 fiscal year because of the COVID-19 pandemic, the company has since seen a surge in revenue and profitability. In the best case, if strong demand persists, shares of the business are nicely undervalued. But even in the worst case, shares do look to be affordable at this point in time. Of course, in this uncertain environment, the picture can change rather rapidly. So investors would be wise to keep a close eye on the business in the near term. And what better way to do this than to keep a close watch on what the firm is due to report in one of its quarterly financial releases. It just so happens that the next one coming out will be released on April 12th of this year, before the market opens. What management reveals at that time could have a significant impact, for better or worse, for investors moving forward.

Understanding CarMax

According to the management team at CarMax, the company operates as the largest and most profitable retailer of used cars in the US. In addition to selling used cars in a retail environment, the company engages in wholesale vehicle auctions. To illustrate just how large the enterprise is, keep in mind that in its 2021 fiscal year, the firm sold 751,862 used vehicles through its retail operations. This was on top of 426,268 vehicles the company sold through its wholesale vehicle auctions. This all comprises the company’s largest segment, known as CarMax Sales Operations. As part of this unit, the company also offers on the spot financing for vehicle purchasers. In addition, the company also provides customers with other related products and services, including an extended protection plan, and vehicle repair services. Under this unit, the company’s used retail operations made up 83% of overall revenue and 67% of the segment’s gross profits during its 2021 fiscal year. A further 14% of revenue came from the wholesale operations, while the remaining 3% of sales was attributable to other miscellaneous activities. By comparison, wholesale activities resulted in 18% of profits, while the other offerings the company provides accounted for 15%.

The other segment the company operates is the CarMax Auto Finance, or CAF, Segment. Through this, the company provides financing solely to customers buying retail vehicles from their business. In particular, this unit focuses on third-party finance providers but using its own scoring models that are based on credit history and other relevant credit data. During its 2021 fiscal year, this particular segment was responsible for financing 42.5% of its retail used vehicle sales. On top of this, it also services all the auto loans that it originates and engages in other related activities. For clarity’s sake, while I did mention that the CarMax Sales Operations of the business does engage in vehicle financing, it merely focuses on the actual process of facilitating the financing, while the CarMax Auto Finance segment is responsible for the implementation of said financing.

Historical Financials

Author – SEC EDGAR Data

Over the past few years, management has generally done well to grow the business. Between 2017 and 2020, for instance, the company grew revenue from $15.88 billion to $20.32 billion. Then, in 2021, the COVID-19 pandemic pushed revenue down to $18.95 billion. The good news for investors here is that this decline was short-lived. That is because, in the first nine months of its 2022 fiscal year, the company reported revenue of $24.21 billion. This compares to the $13.79 billion generated the same time one year earlier. This growth was largely broad-based. For instance, during this nine-month window, sales of used vehicles surged from $11.39 billion to $18.70 billion. After a weak nine-month window for its 2020 fiscal year, with vehicle units down by 12.6%, the surge in the same nine-month window of 2021 amounted to 33.5%. Overall revenue increased though, driven not only by an increase in units sold, but also by higher pricing. Overall pricing for used vehicles was up 23.3%, while for wholesale vehicles it was up by 46.9%. Wholesale vehicle sales, from a unit perspective, performed exceptionally well, surging by 72.7% year over year. Management also attributed some of the improvement to six additional used car stores during this timeframe.

Auto Sales Data

CarMax

As revenue has risen, so too has profitability. Between 2017 and 2020, net income at the company rose from $627 million to $888.4 million. Profits then dropped to $746.9 million in 2021. But as I stated already, 2022 is looking to be a solid year. Net income in the first nine months totaled $991.5 million. This compares to the $537 million reported in the same time frame of 2021. Other profitability metrics have followed a similar path. Adjusting for changes and working capital, operating cash flow grew from $1.11 billion in 2017 to $1.49 billion in 2020. This figure then dropped to $1.31 billion in 2021. For the first nine months of 2022, this adjusted figure came in at $1.47 billion. That compares to the $987.5 million generated one year earlier. We should also pay attention here to EBITDA, which grew from $1.32 billion in 2017 to $1.56 billion in 2020 before dropping to $1.41 billion in 2021. For the first nine months of 2022, EBITDA for the company came in at $1.63 billion. This compares to the $1.02 billion the company reported one year earlier.

Historical Financials

Author – SEC EDGAR Data

When it comes to the company’s upcoming earnings release, analysts have rather mixed expectations. They currently anticipate revenue of $7.58 billion. This stacks up against the $5.16 billion the company reported the same quarter one year earlier. Having said that, it is unclear whether the expectations analysts have provided include the income associated with CAF. This is because CAF income is not counted in operating revenue for the company. This would add another $188.22 million to the $5.16 billion figure I just mentioned. Although analysts expect revenue to grow, the same cannot be said of profits. Earnings per share are forecasted at $1.25, with an adjusted earnings per share figure of $1.30. With the company’s current number of shares outstanding, the GAAP earnings forecast implies net income for the business of $202.10 million. This all compares to the $1.27 per share, or $209.95 million, that the company reported one year earlier.

Investors should keep a close eye on what data comes out. Because the fact of the matter is that much of the increase in pricing and demand for the business might very well be short-term in nature caused by supply chain issues and things of that nature. If management can surprise investors in a positive way on its bottom line, this could have a nice impact in the near term and indicate that the company is stronger than investors anticipate. Generating a miss on the top line could also be telling because of what it would indicate about the state of the demand in the market.

Trading Multiples

Author – SEC EDGAR Data

Even if we were to see a slight worsening in the company’s prospects, this does not mean that shares are not fundamentally attractive. Using the company’s 2022 estimates, which I calculated based on annualizing results seen in the first nine months of the year, investors are currently paying a price to earnings multiple for the business of 11.7. This compares to the 21.6 reading we get if we rely on 2021 figures, while it comes out to 18.2 if we rely on 2020 figures. There are, of course, other ways to value the business. On a price to adjusted operating cash flow basis, the company is trading at a multiple of 8.3. This rises to 12.3 if we rely on 2021 figures and comes in at 10.8 if we rely on 2020 figures. Another way to look at the company is through the lens of the EV to EBITDA multiple. This gives us a reading of 8.1. Using the 2021 results, this multiple increases modestly to 12.9, while the 2020 results push it to 11.6.

To put the pricing of the company into perspective, I decided to compare the firm to five similar automotive retailers. On a price-to-earnings basis, these companies ranged from a low of 4.9 to a high of 23.4. On a price to operating cash flow basis, the range was from 2.1 to 15.8. And using the EV to EBITDA approach, the range was from 4.2 to 15.4. Using our 2022 results, I found that only two of the five companies were cheaper than our prospect at this time.

Company Price / Earnings Price / Operating Cash Flow EV / EBITDA
CarMax 11.7 8.3 8.1
Sonic Automotive (SAH) 4.9 5.6 6.7
Advance Auto Parts (AAP) 22.8 12.6 12.2
O’Reilly Automotive (ORLY) 23.4 15.8 15.4
AutoZone (AZO) 19.6 13.0 12.8
Group 1 Automotive (GPI) 5.0 2.1 4.2

Takeaway

Based on the data provided, I believe that CarMax makes for an interesting prospect for investors who are fans of the automotive retail space. Even if the company were to revert to performance levels achieved in 2020 or 2021, a case could be made that the stock looks undervalued. At the worst, it might be considered fairly priced compared to similar businesses. But these multiples, with the exception of the price to earnings multiple, don’t look bad at all. And when looking at the picture through the lens of the price to earnings multiple, the company is, at worst, overpriced. Due to all of this, I would make the case that shares likely offer attractive upside with limited downside risk. But of course, if management does report a rather bad quarter from an earnings perspective that gives some indication of a new trend forming, that picture could definitely change.

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