CarMax (KMX): Buy, Sell, or Hold Post Q3 Earnings?

Shareholders of CarMax would probably like to forget the past six months even happened. The stock dropped 30.4% and now trades at $44.65. This was partly due to its softer quarterly results and may have investors wondering how to approach the situation.

Is there a buying opportunity in CarMax, or does it present a risk to your portfolio? Get the full stock story straight from our expert analysts, it’s free for active Edge members.

Why Do We Think CarMax Will Underperform?

Even though the stock has become cheaper, we're swiping left on CarMax for now. Here are three reasons we avoid KMX and a stock we'd rather own.

1. Shrinking Same-Store Sales Indicate Waning Demand

Same-store sales is an industry measure of whether revenue is growing at existing stores, and it is driven by customer visits (often called traffic) and the average spending per customer (ticket).

CarMax’s demand has been shrinking over the last two years as its same-store sales have averaged 1.3% annual declines.

2. Low Gross Margin Reveals Weak Structural Profitability

At StockStory, we prefer high gross margin businesses because they indicate pricing power or differentiated products, giving the company a chance to generate higher operating profits.

CarMax has bad unit economics for a retailer, signaling it operates in a competitive market and lacks pricing power because its inventory is sold in many places. As you can see below, it averaged a 10.9% gross margin over the last two years. Said differently, CarMax had to pay a chunky $89.08 to its suppliers for every $100 in revenue.

3. High Debt Levels Increase Risk

As long-term investors, the risk we care about most is the permanent loss of capital, which can happen when a company goes bankrupt or raises money from a disadvantaged position. This is separate from short-term stock price volatility, something we are much less bothered by.

CarMax’s $19.14 billion of debt exceeds the $540.4 million of cash on its balance sheet. Furthermore, its 16× net-debt-to-EBITDA ratio (based on its EBITDA of $1.16 billion over the last 12 months) shows the company is overleveraged.

At this level of debt, incremental borrowing becomes increasingly expensive and credit agencies could downgrade the company’s rating if profitability falls. CarMax could also be backed into a corner if the market turns unexpectedly – a situation we seek to avoid as investors in high-quality companies.

We hope CarMax can improve its balance sheet and remain cautious until it increases its profitability or pays down its debt.

Final Judgment

CarMax falls short of our quality standards. After the recent drawdown, the stock trades at 12.8× forward P/E (or $44.65 per share). This valuation is reasonable, but the company’s shaky fundamentals present too much downside risk. There are superior stocks to buy right now. We’d recommend looking at one of our top software and edge computing picks.

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