Revamping Retail Experience And Finance Innovation Fuels Company's Growth Path

Key Takeaways

• The new order processing system and omnichannel retail strategy emphasize operational efficiency and digital sales growth, aiming for increased margins and sales.
  
• Expansion of Extended Protection Plan and service offerings alongside improved logistics and reconditioning operations focus on higher-margin services and reduced costs to boost earnings.
  
• CarMax faces increased credit risk, market challenges, and pressures on sales and margins due to economic factors, affecting profitability and operational efficiency.

Catalysts

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

• The rollout of a new order processing system across all stores and customer experience centers is expected to enhance operational efficiency and improve the shopping experience for customers, potentially leading to increased sales and improved margins.
  
• The adoption of omnichannel retail experience and the increase in online retail unit sales from 14% to 15% indicate a growing trend towards digital sales, which could lead to higher revenue and potentially improved net margins due to the scalability of online channels.
  
• The focus on expanding the Extended Protection Plan (EPP) and service offerings, which saw a 33% year-over-year increase in other gross profit, suggests a strategic move towards higher-margin services, expected to positively impact future earnings.
  
• Efforts to drive down the cost of goods sold through increased efficiency in logistics and reconditioning operations indicate a focus on improving net margins by reducing operational costs and potentially passing savings onto customers to drive volume.
  
• The testing and expected full rollout of a new full-spectrum underwriting model for CarMax Auto Finance (CAF) aim to capture a larger share of the finance market across all credit tiers, which is anticipated to drive revenue growth and contribute positively to earnings through higher finance income.

Assumptions

• Analysts are assuming CarMax's revenue will grow by 2.2% annually over the next 3 years.
• Analysts assume that profit margins will increase from 1.5% today to 3.4% in 3 years time.
• Analysts expect earnings to reach $1.0 billion (and earnings per share of $6.92) by about November 2027, up from $417.5 million today.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 15.9x on those 2027 earnings, down from 27.9x today. This future PE is lower than the current PE for the US Specialty Retail industry at 16.0x.
• Analysts expect the number of shares outstanding to decline by 1.9% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 10.17%, as per the Simply Wall St company report.

Risks

• The increasing loan loss provision, with a year-over-year provision increase of $23 million, indicates a rising level of credit risk which could affect CarMax’s profitability by increasing its credit losses.
  
• Industry-wide auto loan losses and the specific mention of a $52 million adjustment in estimates for lifetime losses on existing loans reflect broader credit market challenges that could affect CarMax Auto Finance's (CAF) income and overall financial health.
  
• The potential impact of macroeconomic factors such as inflation and high interest rates on consumer affordability and sales volume, which could result in lower retail sales and impact revenue.
  
• The reliance on wholesale vehicle margin which, despite remaining stable, faces pressure from fluctuating market prices and supply chain constraints, potentially affecting gross profits in the wholesale segment.
  
• The anticipated expenses related to optimizing logistics operations, with expected charges of less than $10 million in the near term, which could impact net earnings and affect operational efficiency.

Valuation

• The analysts have a consensus price target of $82.22 for CarMax based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $123.0, and the most bearish reporting a price target of just $58.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $29.5 billion, earnings will come to $1.0 billion, and it would be trading on a PE ratio of 15.9x, assuming you use a discount rate of 10.2%.
• Given the current share price of $75.3, the analyst's price target of $82.22 is 8.4% higher. The relatively low difference between the current share price and the analyst consensus 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.