CarMax ( KMX -3.57% ) investors were bracing for some potentially bad news in the used auto retailer's third-quarter results. While the company had quickly recovered from pandemic-related shutdowns, its business was threatened by further COVID-19 outbreaks, rising wholesale car prices, and a volatile economic environment.
The good news is that CarMax managed to grow sales and profits through these challenges in the period that ended in late November. However, its expansion rate stalled.
Let's take a closer look.
CarMax sales trends were mixed
CarMax sold just over 194,000 used vehicles in Q3, which represented a 1% uptick compared to a year earlier. Its sales volumes were a healthier 3.9% in the fiscal second quarter, though, and the chain also revealed that comparable-store sales fell 1% after rising by 1% in the previous quarter.
In late September, CEO Bill Nash and his team warned investors that several risks were clouding the short-term growth outlook, and these issues did pressure demand at its dealerships. "Some of the factors that we believe impacted sales," management said, "were the surge in COVID-19 cases ... as well as the uncertainty around the election and future stimulus programs."
CarMax got a boost from higher wholesale vehicle sales and extra spending on services like warranty plans so that overall revenue rose 8% -- a solid acceleration compared to last quarter.
Prices jump while profits held steady
A big chunk of the sales growth came from rising prices, with average used vehicle prices jumping over 3% to $21,400. This move inflated revenue but didn't affect profitability because CarMax was mostly passing along the higher prices it was being charged by its automotive suppliers. Gross profit per vehicle held steady at $2,150.
Still, the overall financial picture brightened thanks to cost cuts and improving loan loss estimates in its financing division. These shifts allowed CarMax to spend more cash on advertising, especially around its new omnichannel shopping experience, while still allowing for strong earnings growth. Income before taxes rose to 6% of sales compared to 4.8% of sales a year ago. "We delivered strong [earnings per share] growth this quarter," Nash said in a press release, "thanks to solid execution by our team."
Looking ahead to more volatility
Without issuing a detailed outlook, management made some comments that suggest a volatile period ahead for the business. Many of the same issues that pinched results this past quarter will continue into early 2021 and likely keep a lid on its expansion pace and gross profit margin.
But CarMax is still winning market share even as it introduces more shoppers to its national omnichannel selling platform. Other factors, including stock buyback spending and the planned opening of between eight to 10 new locations next year, demonstrate that executives are still bullish about the long-term growth potential.
Investors holding the stock today might not be thrilled about the prospect of two consecutive quarters of roughly flat used car sales volumes. But that slump is being driven by industry challenges, and not by CarMax losing its competitive hold. On the contrary, the chain is positioning itself for faster growth, and surging earnings, when the used car niche recovers.