CarMax Stalls Out on Sluggish Sales, Falling Earnings

Image source: CarMax.

When an industry is doing extremely well, nervous investors often look for early warning signals that the best of times could be coming to an end. That's been the case lately with used-car retailer CarMax , which has seen its stock slump in anticipation of adverse trends that could hurt profit margin figures in the industry. Coming into its fiscal first-quarter report on Tuesday, CarMax investors were expecting some level of moderation in growth, but the company's figures were even weaker than anticipated. Let's look more closely at what CarMax said about its most recent quarter and whether it can bounce back from its sales slowdown to get its bottom line moving back in the right direction.

CarMax hits a roadblock

CarMax's fiscal first-quarter results didn't live up to what most investors in the company had expected to see. Sales climbed just 2.8% to $4.13 billion, which was about $60 million short of the $4.19 billion consensus forecast among those following the stock. Net income was once again lower, falling a steeper 3.6% to $175.4 million. That produced earnings of $0.90 per share, which was $0.02 less than investors had expected.

Looking at the financial figures that CarMax provided, there was more evidence that the car retailer has started to run into some headwinds. Comparable used-car sales as measured in terms of units sold continued to slow, rising just 0.2% compared to the year-ago quarter. Growth in total sales of used cars stayed relatively steady at 4%, thanks almost entirely to expansion in CarMax's store network. Wholesale unit sales were up 1.8% from a year ago.

Interestingly, CarMax saw a big disparity in sales performance between its lower credit-quality and higher credit-quality customers. The company reported a decline in what it calls its Tier 3 sales mix, which includes third-party finance providers and its own loan origination program for customers with lower credit scores. The mix of those customers dropped nearly three percentage points to 11.9% of used car sales. By contrast, non-Tier 3 comparable sales were up 3.6%.

Other parts of CarMax's business had mixed performance. Sales of extended protection plans were up 6%, and third-party finance fees jumped by nearly 30% because of the more favorable mix of credit risk. However, the decrease in sales of new vehicles put a damper on CarMax's other-sales category, sending the overall figure down 11% compared to the first quarter of fiscal 2016.

Industry trends also showed some pressure on pricing. Used-car prices were flat from the year-ago quarter at $19,858, but wholesale vehicle prices were down 3% to $5,268. An increase in overhead expenses led to margin compression at the operating level, and overall profit margin fell three-tenths of a percentage point to 4.2%.

Can CarMax restart its growth engines?

Even with the difficult quarter, CarMax is sticking with its general plan to expand. The company sees itself opening 17 new stores over the next 12 months, including four stores in the first quarter of fiscal 2018. The West Coast is getting a great deal of emphasis from CarMax management, with the San Francisco, Los Angeles, and Seattle areas getting seven stores in the next year. With plans for a total of 15 openings in fiscal 2017 and 13 to 16 more in fiscal 2018, CarMax is keeping up a steady pace to complement its current store network.

What was somewhat disconcerting, however, is that CEO Tom Folliard didn't choose to include comments in the company's general press release. Folliard announced in February that he would retire as CEO prior to the end of calendar 2016, and the expectation is that current company president Bill Nash will assume the CEO role at that time. Folliard will likely stay on as non-executive chairman of CarMax's board of directors. Still, the release would have been a reasonable time for the company to start to get investors used to the idea of the coming change at the top.

CarMax shareholders weren't happy with the shortfall in expected sales and profits, sending the stock down almost 4% in pre-market trading following the announcement. Given the ongoing challenges that the car retail industry appears to be facing right now, CarMax will have to demonstrate an ability to take greater advantage of the market if it wants to bounce back from its most recent setback.

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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.

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