When people receive cash windfalls, an automobile purchase frequently comes up as a favorite way to spend the money. That helps explain why CarMax (KMX +0.48%), the country's largest used car retailer, posted strong revenue gains this week. The boost was in part due to a flood of delayed IRS tax refunds arriving during the quarter.
The company managed a few important operating wins, too, on the way to announcing its second straight quarter of surprisingly strong growth.
Below are a few key takeaways from the auto giant's results.
Image source: Getty Images.
Healthy sales trends
CarMax is aggressively expanding its store base (having opened 18 new locations in the past year), but its growth ultimately depends on its ability to do increased business out of the 177 lots it already operates. That's why the company has been focused on reigniting sluggish customer traffic through a big digital advertising push. At the same time, management is seeking to improve its conversion rate by convincing more of those browsing shoppers to become buyers.
This quarter's results showed encouraging progress on that score. Comparable-store sales rose 8.2% to nearly keep pace with the prior quarter's 8.7% spike. Management credited a "solid improvement in conversion" and the digital marketing initiatives with driving most of the gains. CarMax also benefited from a surge in federal income tax refunds that normally boost sales during the fourth quarter but, because of a delay, impacted this quarter's results instead.
All the gains came on the used-car side of the business, which managed a 14% boost in sales volumes. The much smaller wholesale segment was flat thanks in part to a tight supply of vehicles in the 7- to 9-year old range.
Profit and financing
CarMax's gross profitability ticked up to 14.3% of sales from 13.9% as decreased costs more than made up for a 2% drop in average selling prices. Expenses also fell as a percentage of revenue, mainly because of a decline in share-based compensation costs. This benefit is purely the result of stock price moves, though, and could easily move the other direction in any given quarter.
Still, these trends combined to push bottom-line profitability up to 4.7% of sales from 4.2% a year ago, translating into $212 million of net income compared to $175 million.
The financing side of the business kept its contribution steady, with income rising at about the same pace as sales. CarMax's loan portfolio is now $10.8 billion, up 11% in the past year. The retailer's financing partners continue to tighten their credit standards, and so riskier buyers represented a smaller portion of the sales base. That shift is likely to keep pressuring results, mainly because of a shrinking pool of automobile buyers with access to credit.
Caution signs
Investors will be watching comps figures over the next few quarters for signs that this latest result was driven by sustainable operating improvements like higher traffic and increased conversion rates rather than a one-time tax refund boost. The industrywide drop in used car prices will be worth paying attention to as well, since management believes it will ultimately help the business by driving demand higher. As long as gross profit per vehicle stays in the $2,100 to $2,200 range that CarMax has managed through many pricing environments over the last five years, shareholders shouldn't be concerned.
Over the longer term, look for an aggressive expansion strategy to lay the groundwork for higher profits. CarMax is on track to add 16 new locations over the next year, including five that represent completely new entries into large-scale markets.
