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Tuesday, July 20, 1999

Circuit City Stores -- CarMax Group
Phone: 804-747-0422
Website: www.carmax.com
Price (7/19/99): $4 3/8


Ever since CarMax's public offering in early 1997, the ride has pretty much been all downhill for shareholders in the auto dealership conglomerate. After accelerating as high as $22 soon after the stock started trading, the value in CarMax's stock has deflated like a tire with a slow leak down to the middle single digits.

Circuit City started CarMax in the early '90s thinking that selling electronics and cars used the same operating skills. Namely, both products are big-ticket items that require tight inventory control and good service after a sale is made. Circuit City sold a chunk of CarMax to the public in order to fund CarMax's expansion as well as to create something that is becoming increasingly popular on Wall Street -- a tracking stock.

CarMax has had a rough few years as a public company. Before reporting a meager $0.03 in earnings per share last quarter, the company had rattled off nine straight quarters of operating losses. While gross top-line growth has been vibrant thanks to the company's fairly aggressive expansion strategy, CarMax's same-store sales have been flat or declining. It's hard to justify opening more locations if the existing ones are unprofitable, and the company has since put the brakes on its heady expansion in an effort to control costs at its first dealerships.

Simply said, CarMax is one tracking stock that lost its traction its operating market as well as with investors.


The Glen Allen, Virginia-based CarMax operates one of the nation's leading chains of used-car superstores. The company's namesake dealerships offer a comparatively large selection of used cars (several hundred at each location) at negotiation-free fixed prices with limited warranties and money-back guarantees. The first CarMax store was opened in 1993 in its hometown of Richmond, Virginia, and the company has expanded to run over 30 CarMax dealerships across the country.

Furthermore, the company recently bought a handful of new-car dealerships and is generally operating the acquired franchises as stand-alone businesses.

CarMax is majority owned by Circuit City (NYSE: CC), and CarMax's stock is merely a "tracking stock" that tracks the performance of the CarMax group within the larger Circuit City parent company. The Circuit City Group holds approximately a 76.3% interest in the CarMax Group with the balance being publicly held.


Income Statement
12-month sales: $1606.0 million
12-month income: ($23.8 million)
12-month EPS: ($0.21)
Profit Margin: N/A
Market Cap: $470.2 million

Balance Sheet
Cash: $14.2 million
Current Assets: $404.6 million
Total Assets: $658.9 million
Current Liabilities: $193.1 million
Long-term Debt: $111.4 million
Total Liabilities: $314.6 million
Shareholders' Equity: $344.2 million

Price-to-earnings: N/A
Price-to-sales: 0.3

*Note -- Figures assume conversion of Circuit City's 76.3% interest in the company into CarMax common stock.


One way to have perhaps avoided the CarMax breakdown would have been to look at the company's same-store sales. Throughout the company's last fiscal year, sales at CarMax's older units were extremely anemic, ending up down roughly 1% for the entire year. This is not exactly a sign of strength in a year with an exceptionally strong economy, low gas prices, and interest rates doing the limbo. Either way, investors who own CarMax should be just as interested in the company's same-store sales figures as investors in any other retail category.

Another factor that continues to weigh on CarMax is the prospect of increased competition. There is no reason that another company can't copy the large inventory and fixed price concept, and several firms, including Wayne Huizenga's market-leading AutoNation (Nasdaq: AN), are now using the same modus operandi. It's not just the lack of profitability that has turned off Wall Street, but also the lack of a substantial competitive advantage over its peers that has many investors thinking twice.


CarMax may be having profitability difficulties with its existing stores, but the company has scaled back its expansion plans in an effort to focus on operating efficiency issues, including managing its inventory better. The company also needs to concentrate on growing its same-store sales figures before national expansion gets back on track. It's hard to tell if these efforts to clean up its existing dealerships will be effective, but looking inward to control costs seems like a smart strategic move.

It's also a fairly safe bet that CarMax will continue to grow down the road, both through acquisitions and organically. On the merger front, CarMax has been buying traditional dealerships left and right, and that activity does not look to stop anytime soon. Plus, with such a large number of the company's car sales being driven by online automotive portals such as Autoweb (Nasdaq: AWEB) and Autobytel (Nasdaq: ABTL), a vertical expansion into the online realm would not be surprising.

Building new units may be on hold while the company tries to repair its internal cost structure, but CarMax still has an aggressive game plan to continue to roll out its haggle-free mega-dealerships. The used-car market remains highly fragmented and is ripe for the type of shifting and consolidation CarMax is bringing to the industry.

On the valuation side, it's fairly easy to call CarMax cheap. The company's market capitalization is less than one-third its trailing sales, with the stock trading barely above its book value. It's important to note that Circuit City's 76.3% interest in the CarMax Group needs to be backed out from the reported financial numbers. While the reported shares outstanding is roughly 25.5 million, the true number of share equivalents for the entire company is closer to 107.5 million shares.

Either way, there is no doubt that CarMax has had profit difficulties in the past, yet the stock could prove to be an interesting turnaround play if the company's efforts to fix its older units bear fruit. One only needs to look as far as a chart of Best Buy (NYSE: BBY) to see what can happen when streamlined internal operations are mixed with national expansion. It would probably not be a waste of time for value-oriented investors to at least kick CarMax's tires for themselves.

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--Paul Larson

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