Submitted by Grant’s Interest Rate Observer
Vehicle Vestibule
It’s alive! Much like Frankenstein’s monster, the automobile market has been jolted back to life by an external shock, this one in the form of the hurricanes which pounded large swaths of the United States last summer. After sales ebbed to a seasonally adjusted annualized rate (SAAR) of 16.03 million in August of last year (the lowest reading since early 2014), the arrival of destructive storms such as Harvey and Irma coincided with an abrupt rebound in sales: Ward’s Automotive Group calculates an average 17.57 million SAAR in the following seven months through March.
For industry leading-used vehicle retailer CarMax, Inc., (KMX on the NYSE), the uptick in new car sales didn’t translate into much good news. CarMax reported fourth quarter earnings yesterday (covering December to February), featuring revenues and earnings per share that each came in well shy of the sell-side consensus, while same store sales declined by a meaty 8% year-over-year. KMX shares enjoyed a bounce in response, although the company’s 5% decline since February 2017 lags the 13% gain from the S&P 500 over that period.
Still in the garage. KMX in white and the SPX in orange. Source: The Bloomberg
Volume, not price, was the culprit. While Carmax’s gross profit per used vehicle inched higher to $2,147 amid a 2.5% year-over-year uptick in average selling price, used vehicle unit sales fell by 3.1% from their year-ago level. The large drop in volumes coupled with sturdy unit profits suggests a conscious decision to hold the line on pricing by KMX management, even as industrywide incentive spending continues to increase.
Average incentive spending rose for a 35th straight month in February according to Autodata, reaching $3,695 per unit from $3,594 year-over-year. For his part, CarMax CEO William Nash observed on the company’s conference call that “incentives have started to come down a bit.” Rising acquisition costs for used and wholesale vehicles were a bigger factor, with Nash noting that “the pricing environment . . . really hits us on two sides. It’s not only that acquisition prices went up on all inventory, but I also think there was pressure on the spread . . . between a late-model used car and a new car both because of our acquisition price going up and new car prices coming down in relative terms year-over-year.”
Taking inventory of an auto market that we judged vulnerable to both credit mishaps and a retrenchment in the used car prices which underpin trade-in activity, Grant’s took a bearish view on CarMax on Feb. 24, 2017 (“Disabled vehicles”). A Feb. 23, 2018 follow-up analysis (“Clunkers, Inc.”) focused on the price vs. volume conundrum facing KMX amid intensifying competitive pressures:
Strong prices were a tonic for CarMax’s revenue growth in the sweet phase of the cycle. From Feb. 28, 2009 to Nov. 30, 2015, the company’s average CarMax selling price ticked up by 23.3%, or 3.2% per annum, to $20,094. Over the same six years and nine months, the CarMax top line swelled by 93.2%, or 10.2% per annum, to $3.5 billion.
If yesterday’s results are any guide, CarMax’s decision to hold the line on pricing has taken a toll on activity. Meanwhile, the credit wheel keeps turning. CarMax’s auto finance unit reported a 21.9% year-over-year uptick in net income during the quarter as its provision for loan losses declined by 16.7% and average managed receivables jumped by 9.4%. Those sunny trends stand in seeming contrast with a Monday report from Bloomberg headed “Subprime New-Car Buyers Suddenly Go Missing from U.S. Showrooms.”
Rising interest rates and new vehicle prices are squeezing shoppers with shaky credit and tight budgets out of the market. In the first two months of the year, sales were flat among the highest-rated borrowers, while deliveries to those with subprime scores slumped 9 percent, according to J.D. Power.
As a corporate entity, CarMax is bullish on itself. On Feb. 28, 2017, the company announced a $4.55 billion share buyback, following a $2 billion repurchase authorization announced on Oct. 22, 2014. That’s no small part of KMX’s current $11.7 billion market capitalization. Those who know the company best have taken a different tack. Since the early September hurricanes, KMX insiders have sold 462,107 shares on the open market, cashing proceeds of just over $34 million. The only open market purchase during that period was of 35 shares
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