The curse of every high-growth stock is that it becomes increasingly difficult to keep investors satisfied with long-term growth trends. Used-car specialist CarMax (NYSE:KMX) is at that point, and coming into this morning's fiscal second-quarter financial report, shareholders were hoping that the company would be able to recapture some of its lost momentum and produce upside surprises on the top and bottom lines. Although CarMax did succeed in posting record results on several fronts during the quarter, overall sales trends continued to fall from past levels, and that has some investors nervous about whether CarMax can keep delivering strong returns. Let's take a closer look at CarMax and why investors sold off the stock today.
CarMax keeps climbing, but is it high enough?
As we've seen in several past quarters, CarMax continues to hit unprecedented heights. Net sales climbed nearly 8% to $3.88 billion, reflecting continued positive trends in the industry. Earnings climbed 11.5% to $172.2 million, and that resulted in record earnings per share of $0.82, topping the consensus forecast by more than a nickel per share. Still, investors had hoped for even better sales growth in the 10% range.
Looking at CarMax's report in detail, growth factors continue to pose challenges for the company. Comparable store sales of used cars gained 4.6%, but that was still slower than last quarter's 4.9% and continues the downward trajectory in comps growth. Expansion in CarMax's network of stores helped push total used-car sales up 9.2%, and wholesale unit sales climbed 8.7%. A quirk in the calendar helped CarMax's wholesale division, as an extra Monday contributed nearly four percentage points to its results because the company was able to conduct an additional auction during the quarter compared to last year's fiscal second quarter. Also, falling average selling prices in the used and new car arenas hurt profits, with drops of around 1% in both areas weighing on overall results.
Other revenue sources also posted mixed results. Service department sales jumped 15%, but that gain was due largely to a change in how CarMax accounts for certain overhead costs. Yet extended protection plan revenue, which is a bigger portion of the segment's sales, gained just 2%. The Auto Finance division saw income rise 6.2% to $98.3 million, with a 16% jump in receivables, but interest margins fell as we've seen in past quarters.
CEO Tom Folliard was content to enumerate the specific elements of CarMax's record performance. "The continued expansion of our store base and growth across our used, wholesale, and CAF operations," Folliard said, "as well as our share repurchase program, all contributed to our record second-quarter earnings per share."
Why are shareholders worried about CarMax?
The main question about CarMax going forward is whether its growth is adequate to support its current valuation. Over the past several months, CarMax shares have corrected downward substantially, falling more than 20% from their highs during the spring. That has gone a long way toward eliminating any sense of overvaluation in the shares, but even with the drop, CarMax stock still trades above 20 times trailing earnings projections. With the overall stock market starting to get jittery, some see CarMax as particularly vulnerable to a slowdown.
Still, CarMax remains optimistic in its own future. The company spent nearly $250 million buying back 3.9 million shares during the quarter. Moreover, CarMax still has an immense war chest of cash available for future buybacks, with authorization to repurchase another $2 billion in stock as of August 31.
Investors, though, want to see more before they'll be certain about CarMax's ability to weather any future storms ahead. The stock finished the day down nearly 5% after this morning's report, having recovered from a nearly 10% drop in the first half hour of the regular trading session. Value investors might well see today's sell-off as a great opportunity to buy CarMax at a discount, but the used-car retailer will still need to demonstrate that it can survive the next downward move in the economic cycle after several years of favorable conditions in the overall market and in its industry in particular.
Dan Caplinger has no position in any stocks mentioned. The Motley Fool owns and recommends CarMax. 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.