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My Takeways From CarMax Earnings

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CarMax (NYSE: KMX  ) missed analyst earnings estimate by a penny, and this sent the stock plummeting, down by 9% during today's trading. Aside from narrowly missing analyst estimates, it was a solid quarter. Revenue increased 13%, and earnings per share increased 15%. Obviously, that was a disappointment to Wall Street.

But, it's possible that Wall Street and the market are overreacting. The company continues to sell more used cars, profit margins were steady, finance income increased (despite lower total interest margins), and the company is continuing to open new stores. From a fundamental perspective, the long-term CarMax story remains intact. Here are my major takeaways from the quarter:

1. Used-car sales grew by double digits
Net sales increased 13%, as the company sold 15% more used car units. This included 10% growth from existing stores and 5% growth from new stores. In other words, the company's customer-friendly model still resonates with customers, and new stores are fueling additional growth.

2. Profit margins held steady
Gross profit per used vehicle remained steady at more than $2,100. Pre-tax and net margins remained steady at 5.9% and 3.6%. Obviously, those aren't high margins, but retail margins tend to be slim. And the company is still able to generate solid returns on equity.

3. Finance profits increased despite lower interest margin
Average managed receivables for CarMax Auto Finance (CAF) increased 24% as the company financed more car purchases. CAF profits -- up 16% -- increased more slowly because the company's total interest margin declined. Total interest margin is the difference between funding costs and interest and fees collected on loans. Total interest margin was 6.8% this quarter, compared to 7.4% a year ago. This drop was probably the main negative of the earnings report, but it shouldn't have surprised watchful followers of CarMax. A month ago, I wrote about the potential for contracting net interest margins. It's a real concern, but it doesn't outweigh all the other factors that could make CarMax a successful long-term investment, in my opinion.

4. New store openings continue
During the third quarter, the company opened three new superstores, and in December, the company opened three more stores. This included two in Philadelphia, a new market for CarMax. It is planning to add another 14 more stores in the next year, including opening up new markets in Portland, Reno, Spokane, and Rochester. This is important, as replicating its successful superstore model across the country is a key reason that the road is wide open for CarMax.

Foolish bottom line
It's amazing how a penny shortfall on earnings and unsurprising news about the car financing market can drive such a large drop in the market valuation of a relatively steady company like CarMax. Given its potential to grow for decades, I'm still excited about the stock at less than 23 times earnings.

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9/27/2016 4:03 PM
KMX $53.70 Up +0.11 +0.21%
CarMax CAPS Rating: ****