CarMax Keeps Facing Sales Challenges

By Markets Fool.com

In recent years, the auto industry has seen record sales for new vehicles, and many have seen that as evidence of a strong U.S. economy. Yet more recently, fears that the auto boom might have topped out have hit shares of used-car retailer CarMax (NYSE: KMX), and coming into its fiscal second-quarter report on Wednesday, CarMax investors had wanted to see signs that growth might return to more typical levels. Unfortunately, the car retailer wasn't able to deliver what most of those following the stock had wanted to see. Let's take a closer look at CarMax and whether its results truly point to potential problems down the road.

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Image source: CarMax.

Where CarMax went off the road

CarMax's fiscal second-quarter results fell short of what investors had hoped for from the car retailer. Sales were up 2.9% to $4 billion, but that was barely half the growth rate that those following the stock had forecast from the company. Net income fell almost 6% to $162.4 million, and even though a drop in outstanding share count helped send per-share figures higher, earnings of $0.84 per share still missed the consensus forecast by $0.04.

Taking a closer look at CarMax's report, the broader for the company was mixed. Comparable used-car sales growth accelerated to 3.1% in unit terms, which marked a vast improvement over last quarter's near-breakeven comps. Total unit sales were up 7%. Yet on the wholesale side, the news was worse, with CarMax posting a 1.3% drop in wholesale sales. CarMax explained that with one fewer Monday in this year's fiscal second quarter compared to the same period last year, the company had one fewer major auction, which tends to drive a large portion of CarMax's wholesale business.

As we've seen in past quarters, the smaller parts of CarMax's business pulled the company in opposite directions. Poor performance in the new vehicle sales category stemmed from the elimination of two of its four new car franchises over the past year. Yet sales of extended protection plans were up 17%, and third-party finance fees jumped by more than 40%, again because of less risky credit extension to customers. That change in sales mix also showed up in CarMax's other numbers, including the fact that the proportion of higher-risk Tier 3 sales fell by nearly a third from year-ago levels, making up just 9.5% of total sales. When you look only at non-Tier 3 sales, comparable store used unit sales jumped more than 8%.

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Pricing pressures were even more evident this quarter than in previous periods. Used-car prices dropped 2.3% to $19,530, while wholesale vehicle prices dropped a more precipitous 4.1% to $5,119.

What's coming down the highway for CarMax?

CarMax remains enthusiastic about its future. In the post-earnings conference call, CEO Bill Nash noted that efforts to boost sales have the potential to tap into a broader national market. "We've launched a new website, we're testing new online shopping capabilities, and we're continuing to build out a new technology infrastructure," Nash said, and the CEO believes that further expansion is necessary to reach the more than one-third of the U.S. population that doesn't have immediate access to CarMax locations.

Moreover, some analysts are hopeful that a shift in sales from the new-car arena to used cars could help CarMax. With wholesale prices falling, the price disparities between new and used cars available in the marketplace are widening. That should spur used-car sales, and although Nash said that he hadn't heard the anecdotal evidence that one stock analysts mentioned during the conference call, he was hopeful that such stories would pan out in the future.

Nevertheless, CarMax shareholders didn't react well to the subpar performance during the fiscal second quarter, sending the stock down 2% following the announcement. Although the company remains confident in its prospects, investors will want to see proof before they start sending CarMax shares back upward.

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Dan Caplinger has no position in any stocks mentioned. The Motley Fool owns shares of and recommends CarMax. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.