It's been just three weeks since used-car hawker CarMax (NYSE:KMX) announced its last batch of bad news. It's just about time for some more bad news, and CarMax didn't let us down. The company confirmed yesterday its most recent predictions for its fiscal second quarter -- a 7% decline in comparable store sales and profits of just $0.27 per share.
This isn't really news, of course. Just a reconfirmation of a preannouncement of what would have been news in two weeks (if they had not already preannounced it twice). What is news is that this quarter, CarMax rolled out nationwide a financing program targeted at "sub-prime" car buyers. CarMax will pair with Drive Financial Services, a Dallas-based provider of auto loans, to extend credit to customers turned down by all of CarMax's in-house financing providers. While CarMax's press release is sketchy on details, it appears that CarMax will grant financing only to buyers meeting Drive's strict parameters aimed at minimizing the risk of default. CarMax will then sell the loans to Drive at a discount.
This way, CarMax can make sales to buyers who could not otherwise afford its cars while it passes on the risk of nonpayment by such buyers. That should insulate CarMax from the losses incurred in recent years by lenders such as American Express (NYSE:AXP) and Providian (NYSE:PVN), who both discovered how dangerous bottom-fishing among credit risks can be. The downside is that CarMax will not reap the full sales price nor profit from wise extensions of credit to good credit risks who only appear to be bad credit risks, a skill mastered by lender Capital One (NYSE:COF) and insurer GEICO, a subsidiary of Berkshire Hathaway (NYSE:BRK.A).
On balance, though, CarMax's plan looks like a good one. While the company still has just 55 used-car superstores in all of the U.S., many of those stores are clustered around cities with large populations of recent immigrants -- a consumer subset that often has difficulty obtaining prime-rate credit. With five stores near Washington, D.C., four stores near both Dallas and Houston, three stores near Los Angeles and two near Miami, CarMax looks well positioned to benefit from pairing with Drive.
Fool contributor Rich Smith owns no shares in any of the companies mentioned in this article.
