Loss Provisions And Tariffs Will Squeeze Margins Yet Spur Efficiency

Key Takeaways

• Increased loan provisioning and potential new car tariffs could strain net margins and impact revenue less favorably than anticipated.
  
• Heavy omnichannel investment and macroeconomic uncertainties may lead to slower revenue growth and unachieved market share targets, impacting stock valuation negatively.
  
• CarMax anticipates growth in revenue and profitability, leveraging cost efficiencies, expanded market capabilities, and strategic investments in operations and infrastructure.

Catalysts

Through its subsidiaries, operates as a retailer of used vehicles and related products in the United States.

• The anticipated increase in provisioning for loan losses at CarMax Auto Finance, due to a more aggressive stance on pulling back Tier 2 loans amid an uncertain macroeconomic environment, could lead to increased financial strain. This may negatively impact net margins as the company absorbs higher provisioning expenses throughout the fiscal year.
  
• Potential new car tariffs could lead to higher new car prices, which might drive consumers towards used cars. However, the increase in used car prices could offset the benefits and might not result in significant market share gains for CarMax, potentially impacting revenue less favorably than anticipated.
  
• With an expected rise in parts costs due to tariffs, operational cost effectiveness becomes paramount. However, if parts prices rise faster than efficiency gains from CarMax’s logistics network and reconditioning operations, it could squeeze net margins despite the company's cost-saving initiatives.
  
• The company’s heavy reliance on omnichannel investments to drive sales growth might lead to diminishing returns if consumer adoption or economic conditions don't support expected sales volumes. This could slow revenue growth, making the stock seem overvalued if the anticipated consumer shifts do not materialize.
  
• A potential delay in achieving market share targets due to macroeconomic uncertainties highlights a risk profile that may not be fully priced into the stock. This includes the unmet timing for reaching the company’s 2 million vehicles sold target, which might represent overly optimistic forecasts that could depress earnings growth if economic conditions deteriorate further.

CarMax Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on CarMax compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming CarMax's revenue will grow by 1.6% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 1.8% today to 2.1% in 3 years time.
• The bearish analysts expect earnings to reach $612.0 million (and earnings per share of $4.01) by about April 2028, up from $500.6 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 22.0x on those 2028 earnings, up from 19.0x today. This future PE is greater than the current PE for the US Specialty Retail industry at 14.4x.
• Analysts expect the number of shares outstanding to decline by 2.18% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 11.41%, as per the Simply Wall St company report.

CarMax Future Earnings Per Share Growth

Risks

• CarMax expects continued sales growth, market share expansion, and double-digit year-over-year earnings per share growth, suggesting potential improvements in revenue and profitability.
  
• The company has introduced cost efficiencies and successfully leveraged its omnichannel capabilities, indicating potential enhancement in profit margins due to lower operating costs.
  
• Record vehicle sourcing through dealer and consumer channels, supported by digital advancements, points to an increase in gross profit driven by higher sales volumes.
  
• Enhancements in CarMax Auto Finance's operations, such as broader credit spectrum lending and securitization, could drive growth in CAF income and positively impact net earnings.
  
• Planned investments in new store locations and reconditioning centers are set to expand capacity, which may support revenue growth by increasing the throughput and availability of vehicles for sale.

Valuation

• The assumed bearish price target for CarMax is $68.42, which represents one standard deviation below the consensus price target of $84.51. This valuation is based on what can be assumed as the expectations of CarMax's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $118.0, and the most bearish reporting a price target of just $55.0.
  
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be $29.6 billion, earnings will come to $612.0 million, and it would be trading on a PE ratio of 22.0x, assuming you use a discount rate of 11.4%.
  
• Given the current share price of $62.33, the bearish analyst price target of $68.42 is 8.9% higher. The relatively low difference between the current share price and the analyst bearish price target indicates that they believe on average, the company is fairly priced.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.