CarMax Inc. - Zacks Investment Research

February 16, 2015

CarMax Inc.

Current Recommendation

Prior Recommendation Date of Last Change

OUTPERFORM

Neutral 02/16/2015

Current Price (02/13/15) Target Price

$67.68 $81.00

SUMMARY DATA

52-Week High 52-Week Low One-Year Return (%) Beta Average Daily Volume (sh)

Shares Outstanding (mil) Market Capitalization ($mil) Short Interest Ratio (days) Institutional Ownership (%) Insider Ownership (%)

Annual Cash Dividend Dividend Yield (%)

5-Yr. Historical Growth Rates Sales (%) Earnings Per Share (%) Dividend (%)

P/E using TTM EPS

P/E using 2015 Estimate P/E using 2016 Estimate

Zacks Rank *: Short Term 1 3 months outlook

* Definition / Disclosure on last page

$67.87 $42.88

43.12 1.74

1,226,599

210 $14,213

7.79 N/A

2

$0.00 0.00

12.9 12.8 N/A

26.9 26.1 23.3

1 - Strong Buy

(Cc) (KMX-NYSE)

SUMMARY

We are upgrading our recommendation on CarMax to Outperform from Neutral based on the company s aggressive store expansion and share repurchase strategy which will help it outperform peers. CarMax posted earnings per share of $0.60 in the third quarter of fiscal 2015, surpassing the Zacks Consensus Estimate of $0.54. The company recorded better results in the reported quarter due to strong performance in used, wholesale and CarMax Auto Finance operations, together with the increase in its store base and the ongoing share repurchase program. Net sales and operating revenues rose 15.8% to $3.41 billion, exceeding the Zacks Consensus Estimate of $3.26 billion.

Risk Level *

Type of Stock Industry Zacks Industry Rank *

Average,

Large-Growth Ret/Whl-Auto Pt

20 out of 267

ZACKS CONSENSUS ESTIMATES

Revenue Estimates

(In millions of $)

Q1

Q2

(May)

(Aug)

2013 2014 2015 2016

2,774 A 3,311 A 3,750 A 4,122 E

2,758 A 3,246 A 3,599 A 4,011 E

Q3 (Nov)

2,602 A 2,941 A 3,405 A 3,682 E

Q4 (Feb)

2,828 A 3,076 A 3,473 E 3,846 E

Year (Feb)

10,962 A 12,574 A 14,227 E 15,661 E

Earnings Per Share Estimates

(EPS is operating earnings before non-recurring items, but including employee stock options expenses)

Q1

Q2

Q3

Q4

Year

(May)

(Aug)

(Nov)

(Feb)

(Feb)

2013 2014

$0.52 A $0.64 A

$0.48 A $0.62 A

$0.41 A $0.47 A

$0.46 A $0.52 A

$1.87 A $2.24 A

2015 2016

$0.76 A $0.84 E

$0.64 A $0.75 E

$0.60 A $0.66 E

$0.59 E $0.65 E

$2.59 E $2.90 E

Projected EPS Growth - Next 5 Years %

16

? 2015 Zacks Investment Research, All Rights reserved.



10 S. Riverside Plaza, Chicago IL 60606

OVERVIEW

Headquartered in Richmond, VA, CarMax Inc. (KMX) operates as a specialty retailer of used vehicles as well as new vehicles. The range of vehicles includes both cars as well as light trucks. It is the largest retailer of used vehicles in the U.S.

CarMax is a holding company, which conducts its operations through wholly owned subsidiaries CarMax Auto Superstores Inc., Virginia; CarMax Auto Superstores West Coast Inc., Virginia; CarMax Auto Superstores California LLC, Virginia; CarMax Auto Superstores Services Inc., Virginia; CarMax Business Services LLC, Delaware; and Glen Allen Insurance Ltd., Bermuda.

CarMax acquires its used-vehicle inventory directly from consumers through its in-store appraisal process as well as from other sources including local and regional auctions, wholesalers, franchised and independent dealers and fleet owners, such as leasing and rental companies. The company conducts the in-store appraisal process through its car-buying centers (about five) intended to increase appraisal traffic and generate incremental vehicle purchases by individual consumers, but not sale of vehicles. Out of the vehicles purchased through the in-store appraisal process, those which do not meet the company s retail standard are sold through on-site wholesale auctions.

In the first nine months of fiscal 2015, CarMax sold 433,011 used vehicles, 7,187 new vehicles and 286,075 wholesale vehicles. As of Dec 19, 2014, the company operated 143 used-car superstores across 72 markets. Most of the company s store locations are in the southeastern U.S. Chicago, Los Angeles, Houston, Dallas and Washington D.C. are some of the cities where the company has a strong presence.

CarMax conducts its used-vehicle operations in three basic retail formats: mega, standard and satellite stores. Mega superstores are approximately 70,000 95,000 square feet, standard superstores span 40,000 60,000 square feet and satellite superstores are spread across approximately 10,000 20,000 square feet.

CarMax also provides customers with a full range of related services including financing of vehicle purchases and sale of extended warranties, accessories and vehicle repair services through CarMax Auto Finance (CAF).

In the first nine months of fiscal 2015, Used Vehicle generated 81.6% of revenues, Wholesale Vehicle contributed to 14.5%, New Vehicle generated 1.8% and Other Sales and Revenues (such as commission on the sales of extended service plans (ESP), service department sales and third-party finance fees) generated 2.1%.

REASONS TO BUY

Unlike its peers, CarMax focuses more on the used-car market, which helps it outperform the industry. The company is among the strongest operators in its peer group, which includes AutoNation and Penske Automotive Group. Furthermore, the company s car-buying appraisal strategy is commendable as this helps it provide an inventory of models, reflecting the taste of each market.

CarMax resumed its aggressive store growth policy during the first quarter of fiscal 2011, driven by improvements in the sales environment in the U.S. In fiscal 2014, the company opened 13 superstores. Seven of these stores were in new markets, helping the company penetrate Philadelphia, Harrisonburg, VA; Jackson, TN; St. Louis, MO; and the Savannah and Columbus

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markets in Georgia. During the first nine months of fiscal 2015, CarMax opened twelve stores. Out of the total, 9 stores were opened in 8 new markets Rochester, NY; Dothan, AL; Spokane, WA, Madison, WI; Lynchburg, VA; Tupelo, MS; Reno, NV and 2 stores in Portland, OR. A store was also inaugurated in the existing market of Harrisburg/Lancaster, PA, which is the third outlet of the company in the state. Other stores were inaugurated in the existing markets of Dallas, TX; and the Raleigh, NC. The company intends to open 13 used-car superstores in fiscal 2015 and 10 15 superstores in each of the next two fiscal years. As of Dec 19, 2014, the company operated 143 used-car superstores across 72 markets.

During the first half of fiscal 2015, CarMax opened eight stores. Out of the total, six stores were opened in new markets Rochester, NY; Dothan, AL; Spokane, WA, Madison, WI; Lynchburg, VA; and Portland, OR, while the another store was inaugurated in the existing market of Harrisburg/Lancaster, PA, which was the third outlet of the company in Pennsylvania. The last store was inaugurated in the existing market of Dallas, TX.

CarMax consistently enhances shareholder value through buybacks. During fiscal 2014, CarMax spent $306 million to buy back 6.9 million shares. Banking on its business fundamentals and ability to deliver growth objectives, the board of directors raised its share repurchase authorization by $1 billion in Apr 2014, slated to expire on Dec 31, 2015., This was expanded by $2 billion in Oct 2014, which will expire on Dec 31, 2016. During the first nine months of fiscal 2015, CarMax spent $800 million to buy back 14.1 million shares under its share repurchase program. As of Nov 30, 2014, the company had $2.58 million of authorization remaining under its repurchase program of which $579.8 million expires on Dec 31, 2015, and $2.0 billion expires on Dec 31, 2016.

RISKS

CarMax is incurring high cash outflow from operating activities. In fiscal 2014, the company had a cash outflow of $613.2 million from operations. Capital expenditures increased to $310.3 million from $235.7 million in fiscal 2013. In the first nine months of fiscal 2015, CarMax had a cash outflow of $784.6 million from operations, compared with $493.1 million in the prior-year period. Meanwhile, capital expenditures increased to $238.9 million from $212.9 million in the first nine months of fiscal 2014. The company expects capital expenditure of around $300 million for fiscal 2015.

Incentives on new cars have encouraged consumers to trade in their old cars for new. This has lowered used-car sales and increased the used-car inventory. This is compelling CarMax to slash vehicle prices to cut used-car inventory, thereby shrinking margins.

The used-car market in the U.S. is highly fragmented and competitive, with the presence of several new- and used-car dealers, alongside private individuals who are also engaged in the business. Moreover, the use of the Internet for marketing vehicles will adversely affect the financials of the company. The increasing online availability of used vehicle information, including pricing, will further aggravate the situation for CarMax as it may fail to differentiate a customer offering from a competitor s one. This in turn will affect retail margins of the company.

RECENT NEWS

CarMax Q3 Earnings & Revenues Beat Estimates, Rise Y/Y Dec 19, 2014

CarMax posted earnings per share of $0.60 in the third quarter of fiscal 2015, ended Nov 30, 2014, highlighting an increase of 27.7% from $0.47 a year ago. Earnings also surpassed the Zacks Consensus

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Estimate of $0.54. The company recorded better results in the reported quarter due to strong performance in used, wholesale and CAF operations, together with the increase in its store base and the ongoing share repurchase program.

Net sales and operating revenues in the quarter rose 15.8% year over year to $3.41 billion, exceeding the Zacks Consensus Estimate of $3.26 billion. The year-over-year improvement was mainly driven by increased used vehicle, new vehicle and wholesale vehicle sales.

Used vehicle revenues appreciated 16.6% to $2.8 billion in the quarter, driven by higher unit sales. Unit sales of used vehicles increased 14% to 139,158 vehicles and their average selling price increased 2.3% to $19,914. Comparable-store used vehicle unit sales rose 7.4% in the quarter. The improvement can be attributed to improved footfall in stores.

New vehicle revenues improved 9% to $54.6 million on higher unit sales. Unit sales of new vehicles increased 10.5% to 2,009 vehicles, while their average selling price decreased 1.4% to $27,056.

Wholesale vehicle revenues rose 10.2% to $481.7 million. Unit sales increased 10% to 90,988 vehicles. Wholesale unit sales benefited due to increased traffic and higher store base. Average selling price of wholesale vehicles was flat year over year, at $5,124.

Other sales and revenues rose 30.2% to $74.5 million on an increase in extended protection plan (EPP) revenues. EPP revenues, including ESP and guaranteed asset protection revenues, increased 26.5% to $61.7 million.

Gross profit increased 17% to $446.6 million or 13.1% of sales from $381.7 million or 13% of sales in the year-ago quarter.

CarMax Auto Finance (CAF)

CAF reported a 6.9% increase in income to $89.7 million from $83.9 million in the year-earlier quarter. The improvement was primarily driven by an increase in average managed receivables, partially offset by a lower total interest margin rate.

Store Openings

During the third quarter of fiscal 2015, CarMax opened four stores. Two stores were opened in new markets Tupelo, MS; and Reno, NV and the other two stores were inaugurated in the existing market of Portland, OR and the Raleigh, NC market. In the first nine months of 2015, the company opened 12 stores. The company intends to open 13 used car superstores in fiscal 2015 and 10 15 superstores in each of the next two fiscal years.

Share Repurchase Program

During the third quarter of fiscal 2015, CarMax spent $327.2 million to repurchase 6.2 million shares under its existing share repurchase program. As of Nov 30, 2014, the company had $2.58 million of authorization remaining under its repurchase program.

Financial Position

CarMax had cash and cash equivalents of $189.9 million as of Nov 30, 2014, down from $664.8 million as of Nov 30, 2013. Total debt (including financing and capital lease obligations, and non-recourse notes payable) rose to $8.8 billion as of Nov 30, 2014 from $7.3 billion as of Nov 30, 2013.

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In the first nine months of fiscal 2015, CarMax had a cash outflow of $784.6 million from operations, compared with $493.1 million in the prior-year period. Meanwhile, capital expenditures increased to $238.9 million from $212.9 million in the first nine months of fiscal 2014. The company expects capital expenditure of around $300 million for fiscal 2015.

VALUATION

Currently, shares of CarMax are trading at 26.1x our fiscal 2015 earnings per share (EPS) estimate of $2.59. The company s current trailing 12-month earnings multiple is 26.9x, compared with the 38.4x average for the peer group and 19.2x for the S&P 500. Over the last five years, CarMax s shares have traded in a range of 13.2x to 26.4x trailing 12-month earnings. The stock is trading at a premium to the peer group, based on forward earnings estimates for fiscal 2015. The current P/E is at a 20.8% discount to the peer group for fiscal 2015. Our long-term Outperform recommendation on the stock indicates that it will perform better than the overall market. Our target price of $81.00, which is 31.3x our fiscal 2015 EPS estimate, reflects this view.

Key Indicators

CarMax Inc. (KMX)

P/E F1

26.1

P/E F2

23.3

Est. 5-Yr EPS Gr%

16.0

P/CF (TTM)

24.3

P/E (TTM)

26.9

P/E 5-Yr

High (TTM)

26.4

P/E 5-Yr Low (TTM)

13.2

Industry Average S&P 500

21.6 25.0

15.2

16.6 15.5

10.7

18.6 38.4 86.1 18.3 15.1 19.2 19.4 12.0

DEI HOLDINGS (DEIX)

N/A N/A

N/A

N/A

N/A

16.7 16.7

Marketing Worldwide Corp (MWWC)

N/A N/A

N/A

N/A

N/A

N/A

N/A

Advance Auto Parts Inc. (AAP)

17.7 14.9

17.1

17.6 20.0 22.5 12.1

AutoZone Inc. ((AZO)

17.2 15.3

13.2

15.0 18.9 19.0 12.9

TTM is trailing 12 months; F1 is 2015 and F2 is 2016, CF is operating cash flow

CarMax Inc. (KMX)

P/B Last Qtr.

4.1

P/B 5-Yr High

4.4

P/B 5-Yr Low

2.1

ROE (TTM)

16.9

D/E Last Qtr.

2.7

Div Yield Last Qtr.

0.0

EV/EBITDA (TTM)

23.7

Industry Average

5.0

5.0

5.0

11.2

0.5

0.0

3.9

S&P 500

5.3

9.8

3.2

25.5

N/A

2.1

N/A

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