If you own shares of CarMax (KMX 0.54%), you'll be glad to know that the stock bolted higher Friday following the release of fiscal first-quarter earnings that trounced analyst estimates, extending a rally underway since late March. As of the latest look, the stock is up 50% from that low, and seemingly still going.
But before celebrating that dubious victory (revenue slipped 17% year over year, while operating earnings tumbled nearly 10%), know that there are more red flags waving for this company. Here are four reasons you might want to take any unrealized profits on CarMax and run.
1. New-car inventory levels are rebounding...fast
The used car market has been impressive of late. But consumers have bought used cars in droves largely because new cars simply haven't been available.
Now, that's starting to change. Cox Automotive reports the total number of new vehicles for sale on dealers' lots reached a two-year high of 1.89 million in March and edged a little higher to 1.9 million (a 54-day supply) in May.
Kelley Blue Book (a division of Cox Automotive) reports that March's average new-car transaction price was below the manufacturer's suggested retail price for the first time in a couple of years. So supply is finally catching up with demand.
This is an indirect threat to CarMax since used car shoppers now have a reason and opportunity to purchase a new vehicle instead.
And this inventory surge doesn't look like it will abate anytime soon. UBS believes the world's automakers will collectively exceed demand by 6% -- or 5 million cars -- this year, setting the stage for more downward pricing pressure. In other words, new vehicles are poised to become even more price-competitive with used cars.
2. Used car prices are coming down
Meanwhile, the pricing power that used car dealers have enjoyed since late 2020 is clearly starting to wane. Cox Automotive's Manheim Used Vehicle Value Index fell 7.6% year over year in May, and was down 2.7% from April's reading, rekindling price weakness that first appeared early last year. Through the first half of June, the Manheim Used Vehicle Index is down another 3.2% from May, and lower by 9.4% year over year.
Data source: Cox Automotive. Chart by author.
The index is still at relatively high levels, and the Manheim index only measures the changing prices on the wholesale used car market (cars bought at auction by used car dealers to be sold to consumers). As Kelley Blue Book points out, though, retail pricing generally lags wholesale pricing by six to eight weeks.
The trajectory of prices is more important to investing right now than the absolute value of used cars. And CFRA Research analyst Garrett Nelson says, "While [CarMax] exceeded low investor expectations, we think pricing and volume trends are likely to remain difficult under a 'higher for longer' interest rate scenario."
3. Banks could soon tighten lending standards
So far, banks and credit unions say they're not raising their lending standards or interest rates specifically in light of fresh economic headwinds. But the data is starting to suggest otherwise. Numbers from Dealertrack (another Cox company) indicate car loan approval rates in May were the lowest they've been in nearly two and a half years, down 2.4 percentage points from a year ago.
And even for banks that have not yet tightened their auto loan standards, such a move might be inevitable. S&P Global reports that as of the first quarter of this year, auto loan delinquency rates in the U.S. eclipsed their previous records reached in 2009 in the wake of the recession-causing subprime mortgage meltdown.
All told, 1.69% of these loans are now 60 days overdue for a payment. That's not a huge number, but by lenders' loan portfolio standards, it's alarmingly high.
Yes, the bulk of these delinquencies come from the subprime auto loan arena, which most conventional banks steer clear of. The more conventional lending market could easily follow suit, though, as was the case for the mortgage market back in 2008.
CarMax is already struggling from these three problems
Despite topping last quarter's earnings estimate, CarMax is already showing signs of these red flags becoming reality, even though they didn't start waving in earnest until nearer the end of CarMax's first quarter.
During the quarter ending in May, not only did revenue slide 17% and profits fall 10%, as mentioned earlier, but total retail unit sales also fell nearly 10% while wholesale unit sales were off nearly 14% year over year. CarMax's auto financing business also saw its income tumble 33% from year-ago levels.
To the company's credit, per-car profitability held steady with 2022's first-quarter levels. It's just making considerably fewer sales than it was then. Even that bright spot could dim soon, however, given the economy.
Connecting the dots
CarMax could well navigate through these headwinds while the economy takes an unexpected turn for the better. Anything's possible. The analyst community is even calling for a solid sales and earnings bounceback next year following this year's lull.
An objective look at the bigger picture, though, shows that CarMax's foreseeable future isn't exactly exciting. There's a great deal working against the used car market at this time that's completely out of management's control, and will be for a while.
It wouldn't be crazy to at least lock in some of your recent gains if you happen to own this stock. And if you're thinking about stepping into a CarMax trade, you might want to hold off just a bit and see how -- or even if -- the company can handle this headwind.
And there's this: While the analyst community believes in the company itself, these same analysts still collectively say the stock is only worth $67.50 per share. That's more than 20% below its current price.
