CarMax, Inc. Is a Great Stock, but Can It Resume Strong Growth?

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Because consumers have become fed up with new- and used-car dealership tactics, CarMax's (NYSE: KMX) no-haggle pricing and sales force with zero incentive to move you into any specific vehicle -- i.e., a more profitable vehicle sale for the company, rather than the right vehicle for you -- has rewarded shareholders with a surging stock price over the past five years.

CarMax has consistently posted average gross profit margins per retail unit sold of about 11%-12%, or about $2,200 per retail unit as of the first quarter, but as you can see below, that dollar figure seems to have peaked in recent years.

Chart by author. Data source: CarMax investor resources.

If CarMax's gross profit per unit has indeed peaked, the used-vehicle retail king will have to grow its total profits through new store openings, and thus an increase in total units sold, to reward shareholders going forward.

More stores is what the doctor ordered Growing its store count is exactly what CarMax plans to do to help generate more company revenue and profits. As of the fiscal first quarter 2015, CarMax's stores only reached about 63% of the U.S. population. Also, in the markets in which CarMax is present, the company has a roughly 5% market share of used vehicles sold aged zero to 10 years, and a total market share of less than 3% nationwide.

Source: CarMax European Investor Presentation.

As CarMax aims to deliver big growth for investors, the strategic answer looks to be in small markets.

Until a year or two ago, CarMax typically only put stores in midsize and large markets with TV viewing populations of between 600,000 and 3 million people. CarMax's production stores, which have the ability to recondition vehicle trade-ins for resale, usually occupy 10 to 25 acres and hold as many as 300 vehicles, according to Automotive News.

Now, CarMax is reaching smaller markets with stores that have an even smaller footprint, say, between three and seven acres, but still boast a full production shop like larger stores. At the end of CarMax's 2015 fiscal year, the company operated six smaller stores but has identified at least 80 markets that will support a smaller CarMax store. That's a lot of potential growth for a company currently operating roughly 150 stores in the U.S. market.

CEO Tom Folliard said in a conference call: "We have incredible variation and incredible capabilities as a company to be able to go after just about any market now. We can open a market with selling as few as 75 cars a month."

In addition to CarMax opening new stores in larger cities such as Cleveland, Minneapolis/St. Paul, Boston, San Francisco, Seattle, and New York, these smaller stores will be key for the auto dealer to achieve its goal of opening between 13 and 16 new stores annually over the next few years.

The reason it's important for CarMax to continue opening new stores in smaller markets is that its retail business is the company's bread and butter. CarMax generated 57% of its fiscal-year 2015 profits from retail units sold, while wholesale, service, and finance segments respectively contributed 16%, 14%, and 13% of total profits during the same time period.

Chart by author. Data source: CarMax investor resources.

Ultimately, if CarMax is going to deliver incremental sales, which would drive profits and shareholder value higher, smaller-market stores will play a huge role in making that happen. So far, CarMax has proven that it can sell vehicles extremely well while generating a consistently large gross profit margin per unit, and as the company zeroes in on smaller markets, shareholders should continue to be rewarded in the years ahead.

The article CarMax, Inc. Is a Great Stock, but Can It Resume Strong Growth? originally appeared on

Daniel Miller has no position in any stocks mentioned. The Motley Fool recommends and owns shares of 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.

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