Coming into this morning's earnings release, used-car selling network CarMax (NYSE:KMX) had given investors reasonably good returns, with shares climbing 12% so far in 2014. Most of those gains came in the aftermath of exceptional fiscal first-quarter results, and so shareholders hoped to see continued growth in key business metrics. Yet even though CarMax touted new records for its fiscal second quarter, the stock didn't respond well to a shortfall in earnings growth. Nevertheless, the real question shareholders must ask is whether the company's long-term growth prospects remain intact.
Why CarMax stalled out this morning
From the headline numbers, CarMax seemed to be firing on all cylinders. Revenue growth of nearly 11%, to $3.6 billion, was greater than most investors had expected, and a 10% gain in net income sent earnings per share up almost 13% to $0.70, which was ahead of the $0.67 per share that many thought the car seller would deliver. In the earnings press release, CEO Tom Folliard touted "continued growth in our store base and improvements across our used, wholesale and [CarMax auto finance] operations" as making a team effort in producing record fiscal second-quarter results.
But some less encouraging numbers left CarMax shareholders wanting more. A one-time award of settlement proceeds added $0.06 to CarMax's EPS for the quarter; if you adjust quarterly earnings for that extraordinary item, EPS fell short by $0.03 per share. And although total used unit sales rose 6.3% and wholesale unit sales climbed 7.4%, most of that growth came from expansion in CarMax's store network. Looking only at comparable used-car unit sales, CarMax managed a slim 0.2% rise from the year-ago level. The expense side of the income statement showed a 12.5% hike in overhead after adjusting for the settlement proceeds, as share-based compensation and a rising store count added to costs.
CarMax ramps up for growth
Even as short-term traders focus on CarMax's near-term struggles, the company's expansion plans still point to a promising future. CarMax said this morning it expects to open 13 new stores within the next 12 months, with four of those coming online during the current fiscal quarter. Seven of those new stores represent expansion in markets in which CarMax already has a presence, but half a dozen of them will give local customers their first taste of the CarMax experience, including consumers in Minneapolis/St. Paul, Cleveland, and Reno, Nev.
CarMax's expansion comes at a cost, as the company expects total capital expenditures of about $325 million this year. Yet as part of its overall growth strategy, CarMax doesn't expect expansion to slow in the future, saying it will target opening 10 to 15 stores in each of the two fiscal years following the current one.
One big question facing CarMax is the role of its auto finance division. Income for the segment rose almost 10% during the quarter, with receivables climbing 18.5% as a result of the company's efforts to extend more direct credit to customers. Yet interest margin fell from 7% of receivables a year ago to 6.6%. If the long-awaited rise in short-term interest rates actually occurs at some point, it could further hamper the auto finance division's profitability. Given the importance the division has played in CarMax's overall results, getting auto finance back in shape needs to be a high priority.
With the stock immediately dropping almost 5% in pre-market trading after the announcement, CarMax shareholders don't seem confident about the company's ability to bounce back. Yet the auto dealer's track record of responding to changing conditions should shift your focus toward CarMax's longer-term efforts to sustain its growth and continue to build its reputation in the industry.
Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends CarMax and Tesla. The Motley Fool owns shares of CarMax and Tesla. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.