3 Takeaways From CarMax's Earnings Report

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Customer traffic had been slowing for most of 2017, but shareholders were still optimistic that an improving economy, plus the start of tax refund season, might help CarMax (NYSE: KMX) engineer a modest rebound this quarter.

Instead, the nation's biggest used car retailer revealed this week that sales growth turned negative in the fiscal fourth quarter. Let's take a closer look at the results.

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Disappointing growth

Revenue inched higher by less than 1% as the benefit of a rising store base was almost completely offset by weakening results at CarMax's existing locations. Comparable-store sales fell 8%, versus a 3% increase in the prior quarter and a 5% improvement in the fiscal second quarter. The slump led to a 2% comp boost for the full fiscal year, which is about half the expansion pace CarMax managed in 2016.

This quarter's decline came as new car dealerships ramped up their promotions, which tends to lessen the attractiveness of the late-model used cars that CarMax specializes in selling. That difficult sales environment helps explain why customer traffic dipped, but the retailer also failed to improve on its conversion rate, or the percentage of browsers that become car buyers. Management implied that the company could do better. "We're disappointed in our fourth quarter comparable store unit sales performance," CEO Bill Nash said in a press release, "which we believe was partly affected by macro pricing factors resulting in a softer sales environment."

Profit give and take

CarMax's profits benefited from a solid 2.5% uptick in average selling prices that likely reflected a continued shift toward more expensive models. The retailer also managed to keep its gross profit per vehicle steady at $2,100.

However, the drop in comparable-store sales hurt earnings in two ways. First, by reducing sales volumes, it pushed gross profit margin down to 13.1% of sales from 13.9% a year ago. Second, the weaker volume led to less demand at CarMax's service centers. As a result, gross profit fell 4.5% compared to the prior-year period.

On the bright side, CarMax posted a strong bump in profits from its financing arm that helped it offset some of the negative impact from higher costs tied to its store expansion and increased investments in the e-commerce sales channel.

Steady store plans

The weaker customer traffic results didn't seem to worry the management team enough to cause a downgrade in its store growth plans. After opening 15 locations in 2017, Nash and his team are targeting 15 additional lot launches in 2018, followed by store growth of between 13 and 16 lots in 2019. The company is planning to shift its openings toward smaller markets, though, which will represent two-thirds of this year's new locations compared to roughly half last year.

CarMax still plans to boost capital spending as it aggressively expands beyond the 90 major markets it currently covers in the U.S. that amounts to roughly 72% of the country. After all, while the retailer would like to see stronger sales growth at its existing locations, its steady profitability under difficult selling conditions implies it has plenty of room to expand from its less than 5% market share of national lightly used car sales.

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Demitrios Kalogeropoulos has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends CarMax. The Motley Fool has a disclosure policy.