People aren't spending like they used to. Stubbornly high inflation and rising interest rates are changing how people spend their money.
CarMax's (KMX -0.37%) latest earnings show how much people felt pressure from inflation when it missed earnings estimates and issued a warning to investors. Vehicle affordability and low consumer confidence weighed on the company's earnings, and its stock plummeted nearly 25% following its earnings call on Sept. 29. Others in the auto industry also saw their stock prices fall as investors readjusted expectations for slower vehicle sales.
Ally Financial (ALLY -1.03%) is one of the largest full-service automotive lenders in the U.S. and is a stock that Berkshire Hathaway CEO Warren Buffett keeps piling into during this bear market. Ally investors may wonder if CarMax's disappointing earnings spell trouble for the lender. Here's what you need to know.
Consumers are prioritizing spending differently
CarMax recently announced disappointing earnings and missed on estimates when it posted revenue of $8.1 billion, compared with analysts' expectations of $8.5 billion. Earnings per share were $0.79, far below estimates of $1.39. Demand for used vehicles was weak in the quarter due to low consumer confidence, vehicle affordability, and higher interest rates.
CarMax CEO Bill Nash said, "I just think consumers are prioritizing their spending a little differently," and added: "I think it's just a continuation of the deterioration of the overall consumer." He said that inflation increases costs across a wide range of products, and consumers prioritize smaller purchases over larger ones as a result. That and higher interest rates make financing a used vehicle more expensive.
The company expects weak sales to continue for at least another quarter, but its growth could be under pressure for a few quarters if economic conditions don't improve.
Ally has this advantage that could help it weather the demand slowdown
Ally Financial is a top lender in the automotive space, which produces 65% of its revenue and 90% of its pre-tax profit. The bank has 22,400 dealer relationships across the U.S.
During its second-quarter earnings, it saw auto originations of $13.3 billion -- its highest level since 2006 and its eighth consecutive quarter of growing net financing revenue. At the time, the company said there was healthy consumer demand that it expected to remain robust.
Image source: Getty Images.
There's a good chance Ally will see its auto financing revenue slow down when it announces earnings on Oct. 19. However, Ally could be better positioned than CarMax because of the customers it serves.
Daniel Imbro, a managing director at Stephens Inc. who covers CarMax and other auto retailers, said the demand drop was "almost solely because of the affordability issues." The population most affected by inflation are those in a lower income bracket, who find food and shelter costs making up a more significant share of their monthly expenses.
Ally concentrates on higher-income segments of the population that make up most of its loans. The average income of its consumers is $100,000, and CFO Jenn LaClair told investors in July that "we don't see a slowing down from a demand perspective" from these customers.
Ally stock hasn't been this cheap in years
Ally should have no problem weathering a slowdown, and its balance sheet is robust. The bank has over $3.7 billion in cash equivalents and total liquidity, including highly liquid securities and unused borrowing capacity of over $28 billion.
The stock trades at a cheap valuation with a price-to-earnings ratio (P/E) of 4.4, which is below its 10-year average. It also trades below book value, with a price-to-tangible book value of 0.88 -- giving investors what appears to be a margin of safety.
Ally could see its auto lending business slow down in the next few quarters. However, its focus on higher-income earners could insulate it from some of the affordability issues that have dampened demand across the industry.
