Will CarMax Keep Putting the Growth Pedal to the Metal?

Source: CarMax.

Investors have to be pleased with the performance of car retail specialist CarMax this year, as the stock has risen nearly 30% so far in 2014 thanks to solid demand for cars and trucks from U.S. customers. Even though CarMax didn't give investors as much growth as they'd hoped to see when it reported its quarterly results back in September, those following the stock now expect CarMax to reaccelerate and produce strong numbers when it announces its fiscal third-quarter results on Friday. In particular, if CarMax can deliver earnings growth that maintains or exceeds its strong sales, then shareholders will likely celebrate the report and send the stock still higher.

CarMax caters to a new breed of customers who don't want the annoyance of having to deal with sales tactics and gimmicks in order to get the vehicle of their choice. As a result, as Fool co-founder David Gardner pointed out in his original recommendation of CarMax early last year, CarMax has managed to become the top seller of used vehicles across all networks throughout the nation. Let's take an early look at what's been happening with CarMax over the past quarter and what we're likely to see in its report.

Stats on CarMax

Source: Yahoo! Finance.

What's around the bend for CarMax?Investors haven't been quite as optimistic over the past few months about CarMax's earnings prospects, as they've kept November-quarter estimates unchanged and actually pulled back on their earnings-per-share views for both fiscal year 2015 and fiscal year 2016 by about 1%. The stock, though, has kept on climbing, with gains of about 15% since mid-September.

That strong stock performance is all the more surprising given the difficult fiscal second-quarter that CarMax had. Even though CarMax produced used-vehicle unit sales growth of 6.3%, most of those gains came from the company's expanding network of locations. Comparable unit growth in used vehicles rose only 0.2%, and when you take out a favorable one-time settlement that helped boost quarterly net income, CarMax's earnings per share fell short of the growth rate that investors had wanted to see.

Source: CarMax.

One concern some shareholders have is that CarMax is using share buybacks to prop up its stock. In October, CarMax said it would spend $2 billion more on stock repurchases between now and the end of 2016, more than tripling the remaining $900 million from its previous buyback authorization. Despite CEO Tom Folliard saying that the buyback "reflects both confidence in our ability to fund the company's growth plan and a continuing commitment to increase shareholder value," CarMax will likely have to use not only available operating cash but also credit facilities and new indebtedness in order to pay for the new buybacks.

In addition, CarMax will face renewed competition from an unexpected corner. Warren Buffett's Berkshire Hathaway announced in October that it would buy privately owned car-dealership chain Van Tuyl Group, with an eye toward rebranding the business under the Berkshire Hathaway Automotive name. As interest in the highly fragmented auto sales business heats up, CarMax will need to take steps to fend off existing and new rivals and emphasize the competitive advantages its vast network has.

In the CarMax earnings report, investors need to look closely at the company's future expansion plans as well as how its auto-finance division performs. Even though the overall business remains sound, CarMax has to reassure investors that it will continue to turn rising sales into faster-growing profits. If it can do so, then CarMax's impressive run could continue to pay dividends for shareholders.

The article Will CarMax Keep Putting the Growth Pedal to the Metal? originally appeared on Fool.com.

Dan Caplinger owns shares of Berkshire Hathaway. The Motley Fool recommends Berkshire Hathaway and CarMax. The Motley Fool owns shares of Berkshire Hathaway and 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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