CarMax Gains Traction

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Headline from this morning's Wall Street Journal: "Auto Makers See a Ray of Hope."

Story behind the headline: Sales were down across the industry, with General Motors (NYSE: GM), Ford (NYSE: F), Toyota (NYSE: TM), Honda (NYSE: HMC) and all the rest combining to report fewer than 860,000 U.S. car and light truck sales last month -- a 37% year-over-year decline.

Granted, that was better than February's 41% decline, but the real story here is that things are tough all over.

No so bad at CarMax
The numbers named above, of course, refer to new-car sales. But if the carmakers are struggling a lot, used-car resellers such as CarMax (NYSE: KMX) are having at least a slightly better time of things. This morning, CarMax reported that its sales (in units) of used cars dropped 21% for the fiscal fourth quarter (total revenue declined 28%). That's nothing to brag about, certainly, but it was less of a drop than Detroit experienced.

The story behind the story
But this isn't just a story of some companies performing less abysmally than others. There was actual good news at CarMax as well. Namely, profits. If you recall from last quarter, CarMax has taken steps to prepare itself to weather this downturn: slashing inventory, putting expansion plans on the shelf, and laying off workers. 

These moves were meant to improve profit margins, and CEO Tom Folliard specifically told investors that he did not intend to fritter away margin gains in racing rivals such as AutoNation (NYSE: AN) and America's Car-Mart (Nasdaq: CRMT) to the bottom. Folliard promised to hold the line on prices, and keep the profits for CarMax.

Mission accomplished
The fourth-quarter's numbers show those efforts bearing fruit. Gross margin jumped to 15.7% for the quarter, from 12.6% in the year-ago period and from 12.8% in the third quarter, and CarMax returned to operating profitability. Bottom line, the company ended the quarter with a 2.6% net profit margin ($0.17 per share) and about 0.8% net margin ($0.27) for the year.

Meanwhile, the company generated its first actual free cash flow in seven years. Thanks to inventory liquidation and cuts in capital spending, CarMax pushed through $78.9 million in free cash flow for the year. Looking forward, with the capital budget slashed to just $20 million for fiscal 2010, I think it's safe to say we'll see far more cash roll in this year as well.

So CarMax is doing better than the people who build the cars it sells. But is relative outperformance reason enough to own the stock? Need some help answering that question? Take our Motley Fool Inside Value newsletter out for a free test-drive and get the team's latest thoughts on CarMax, which they first recommended to subscribers in 2006.