CarMax Guns Its Growth

Here at the Fool, we know you have a life. Between working while the sun shines and catching Z's when it doesn't, you might find it hard to keep up on Wall Street events -- corporate "investor conferences," for instance.

These meetings appear to benefit investors, but the companies behind them rarely transcribe their proceedings and file them with the SEC. As a result, unless you can attend in person, you're often left out in the cold. That's where our "Fool on the Street" series comes in. We listen to the conferences so you don't have to.

Without further ado ...
Today, we'll recap the news from CarMax's (NYSE: KMX  ) Sept. 5 presentation at the Goldman Sachs 14th Annual Global Retailing Conference, where CEO Tom Folliard made the company's case to Wall Street. As presentations go, this one was on the long side. Rather than go point by point and bore you to tears, I'll focus on the three most interesting developments.

Competition? Pshaw!
Fools who don't follow CarMax closely (and, I admit, I've let my own attention slide from time to time) will want to know that the company is getting a bit of the sincerest-form-of-flattery treatment from its rivals. In the past, AutoNation (NYSE: AN  ) tried out the superstore-for-cars approach that CarMax has made such a success, but it later ditched the idea. Now comes little Lithia Motors (NYSE: LAD  ) to take another stab at the concept.

Asked about Lithia's opening of a "used-car stand-alone store," Folliard described it as a "business model ... obviously very similar to ours in terms of 'no haggle' and the way they're going to treat their customer." Now, other companies might see a rival duplicating their business plans and decide to file an infringement suit. But CarMax takes the opposite approach. Says Folliard: "I think I'm appropriately paranoid about that, but at the same time, I welcome the competition."

"Paranoid" ... that actually does seem to be the right word. Reading up on Lithia reveals that its annual sales are only half of CarMax's. And although it grosses more on its sales, Lithia isn't nearly as efficient an operator as CarMax, which beats it by more than a full point of operating margin and boasts returns on capital more than three-and-a-half times those of Lithia. You just gotta love that kind of "competition."

Bigger is better, but small ain't half bad
Speaking of competition, CarMax is opening a new front -- actually, several new fronts -- in its battle for market-share supremacy. AutoNation and Penske (NYSE: PAG  ) may have an edge over CarMax on sales today, but perhaps not for long, the way things are going.

Following in the footsteps of Wal-Mart (NYSE: WMT  ) , one of the first retailers to begin thinking in terms of the bigger-is-better adage, big-box car-seller CarMax is experimenting with smaller-footprint locations, even as it continues to rapidly grow its megastore base.

For example, CarMax opened a self-described "very small" location in Charlottesville, Va. How small is "very" small? Folliard says the idea is to get as small as 100 to 150 sales per month -- this compared with the average of 426 cars a CarMax superstore sells in a month. The Charlottesville location has been open for less than a year, however, and Folliard thinks "we need to get a few more of those open and read the results for a little while before we can really tell" whether the small-store concept is worth pursuing.

In contrast, one small-is-better idea CarMax has decided to pursue is small locations dedicated entirely to what many people might think is just a corollary to its main business of selling cars: buying cars. Way down in Atlanta, CarMax set up a "car-buying center" -- which means just what you'd imagine. This store format buys used cars from all comers, whether they go on to buy a vehicle from CarMax or not. Then, mining its historical database on past transactions, CarMax decides whether it can profitably refurbish the "trade-in" and resell it at a profit, or whether it should unload the car on the wholesale market. Either way, though, CarMax admits that it views "buying used" as a profit center for the business, and not a loss leader aimed at getting customers to buy overpriced "new" cars when they trade in their old cars.

In evidence of how well this idea is working, CarMax has already opened a second stand-alone car-buying center in Raleigh, N.C., and plans to open three more this year -- one each in Dallas, Baltimore, and Bradenton, Fla. I'm guessing that if CarMax weren't making money at these stores, it wouldn't be planning to quintuple the store base on this format in fewer than 12 months.

Give something back
A final point before we close, and this one's a shocker. Pushed by the analysts to describe how the company aims to improve profitability over time, Folliard made an astonishing revelation: He doesn't.

Oh, Folliard sees plenty of ways CarMax could improve profitability: by growing the store base as described above and by cutting costs. In fact, Folliard already knows where to find "the single biggest area for us to pull cost out of the system." CarMax plans to spend $1 billion reconditioning 350,000 cars for resale this year. Yet his focus remains on driving comps, and rather than use the savings to add to the gross margin, Folliard wants to focus on driving comps by reducing the average retail price of $17,700. So margin improvement is on the back burner for now.

Fair warning to CarMax's competitors: You'd better either find the gas, or clear the road. As long as Folliard is at the wheel, the profit margin will continue to take a back seat at CarMax. He's on a straight route to market share-ville, cruise control set, and no stopping for bathroom breaks.


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