CarMax, Inc (KMX) Is Compelling and Profitable Unit Growth Story: RiverPark

RiverPark Funds is bullish on CarMax, Inc (NYSE:KMX), an $11.65-billion market cap retailer of used vehicles. In its Long/Short Opportunity Fund Q4 Investor Letter, the New York-based investment firm discussed its investment thesis on CarMax, calling the company as “one of the most compelling and profitable unit growth stories in U.S. retail with an excellent management team and a fortress balance sheet.” Let’s take a look at the fund’s comments.

CarMax (Long): After four straight quarters of better-than-expected results, CarMax reported a mixed third quarter that led to its shares being a top detractor from performance for the quarter. While EPS grew 13% for the quarter, in-line with Street expectations, sales were a bit disappointing (same store sales increased 2.7%, below consensus of 4.5% growth). The ebb and flow of the value proposition for used vs. new cars appeared to cause some slippage in demand for the company’s late model, used car dominated inventory during the period (in contrast, the company’s wholesale division and its lending divisions each exceeded expectations). We have seen these swings between the new and used markets many times during the years that we have been following KMX as a public company and do not believe that they are predictive of the company’s growth prospects or of the industry’s long term trends. Nevertheless, we will be watching closely for signs of normalization in 2018.

It remains our belief that KMX is one of the most compelling and profitable unit growth stories in U.S. retail with an excellent management team and a fortress balance sheet. In the near term, we expect credit normalization as well as strong used car industry momentum to continue to support strong quarterly earnings comparisons while, over the longer term, we expect the company to double its store base and more than double its earnings, while also generating substantial excess capital to return to shareholders. For 2018, the new tax laws will be of material benefit to KMX as the company’s effective tax rate is projected to drop from an above average 37% to approximately 23%, providing a substantial lift to 2018 earnings and free cash flow. Following this recent pullback and incorporating the new tax rate, KMX shares trade at a substantial discount to the market for what we perceive to be a well above average growth business.

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Richmond, Va.-based CarMax, Inc (NYSE:KMX) is the largest used-car retailer in the United States, operating more than 180 stores. For the third quarter ended November 30, 2017, the company reported an 11% year-over-year (YoY) increase in net sales and operating revenues to $4.11 billion, while net earnings rose 8.9% year-over-year to $148.8 million, or $0.81 earnings per share. Used unit sales in comparable stores increased 2.7% year-over-year, with total wholesale unit sales jumping 9.1%.

Shares of CarMax, Inc (NYSE:KMX) are up just 0.47% so far this year. The stock has dropped 4.6% over the past 12 months. Analysts, polled by FactSet, have an average rating of ‘Overweight’ and an average price target of $77.88 on the stock, which closed at $64.43 on Friday.

Meanwhile, a number of hedge funds covered by Insider Monkey also see a value in CarMax. As of the end of September, there were 37 funds in our database that hold shares of the used car retailer, including Immersion Capital, MIK Capital, and Giverny Capital.