Selling leased car to carmax

selling leased car to carmax

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selling leased car to carmax

  • CarMax Inc. is an expensive company that lacks any true advantages in a competitive and cyclical industry.
  • Several trends in the industry will soon dampen CarMax's growth prospects.
  • Carmax's extremely high multiples relative to its competitors are unjustified.

Opportunity Description: Carmax (NYSE: KMX) operates in a highly competitive industry. As a market leader in the used car industry it trades at multiples almost two times its peers. Intense competition has already begun to impact its margins and it missed 2Q revenues. Carmax's economic moat will continue to erode, making its current premium unjustified, thus making it a viable short.

CarMax was first publicly traded in 2002 after being spun off from Circuit City. KMX is the largest used car retailer, and it generates revenues from two major sources: the used car business and CarMax Auto Finance. The used car business is two-fold. First CarMax buys used cars from individuals or wholesale auctions, refurbishes them if necessary, and then sells them through their retail segment or their wholesale segment, earning 82.6% and 14% of retail revenue respectively. Cars that don't get in store appraisals and meet retail standards are pushed to the wholesale auction. They also earn 3.4% of retail revenue on ancillary services such as extended protection and vehicle repair.

CAF earns revenues on interest payments from financing customer loans. The financing is segmented into three tiers, depending on credit rating. Tier 3 or sub-prime lenders are then securitized by third-party financers for a fee. Currently CarMax reaches 65% of US markets but only sells 5% of used cars in those markets. The business is highly fragmented, but CarMax has enjoyed stable margins because of increased efficiency in its purchasing processes. Price growth has also been strong with NADA's Used Car Price Index increasing 18%. However, with net margins hovering around 4% that means that most of the benefit has been passed to the consumer. This is pretty indicative of the competitiveness of the industry and the purchasing power of the consumer. The CAF segment is contingent on used sales growth as well, and CarMax has done well to increase its own financing product penetration, increasing it from 39% in 2013 to 45.3% in 2016.

Auto loans in general have become a lucrative industry as well, with car purchases driven by lower gas prices and easy credit. CarMax holds a competitive advantage in its CAF segment because it can offer competitive rates at its locations.

Car purchases overall have been increasing since 2010 with 2015 seeing a record of 17.5 million cars and light trucks sold. Within this trend, leasing has become popular because it offered an inexpensive option to drive nicer cars. There is a three-year lag between lease originations and when those vehicles become off lease they get sold in the used retail market. It is expected that 3.1 million off lease vehicles will flood the market this year. This climbs up to 3.6 million in 2017 and 4 million in 2018, which comes out to around 20% growth in lease cars entering the market. This rush of off lease vehicles is projected to decrease prices 2.5% annually to 2018. Auto loans have also climbed up to record highs since the financial crisis to a value higher than $1.1 trillion. Easy credit has driven up car purchasing rates and also driving up car prices. For many industry experts there looms the threat of an auto bubble popping. As these loans accumulate, there has also been a noticeable increase in delinquency rates.

Why This Company Is Overpriced

Sellside is still somewhat bullish about the company even after the 2Q revenue miss. They blame the decreasing segment of subprime borrowers as the primary headwind. They remain opportunistic citing 3.1% same store sales growth as a bright spot. Moreover, they believe that an 8% growth in car sales demonstrate Experian's industry report that consumers are shifting from the new to used car industry. These factors in addition to CarMax's rapid expansion plans to open new stores, have created a mixture of hold and buy ratings from most researchers.

Depressed car prices means two things. CarMax's top line will get cut significantly, as a new flood in the supply of used cars will put downward pressures on the competitive industry. In theory, this should mean lower costs for CarMax as they also buy used costs. However, this is not the reality because CarMax's current supply are primarily individual consumers who sell their cars through the appraisal process. Moreover, what happens to offlease cars is up to lease dealers, who can choose to sell this fleet themselves. Based on industry reports, more lease dealerships have begun to recognize the opportunity of the used car market, which is 3x the size of the new car industry, to expand growth. The off lease cycle would not influence more consumers to enter the market, which demonstrates the limit of CarMax's supply chain. CarMax can look to capture some of the lower costs by going through wholesale auctions, but that buying process is typically less profitable because the cars are of lower quality. The key problem with CarMax's current model is that they are not leveraged to take advantage of the off lease cycle to maintain margins. Gross margins, which have been stabilized for the last 4-5 years, will get squeezed, and CarMax will have to compete with relatively more lease dealers entering the used car market. CarMax has also demonstrated recently its inability to get access to the off-lease inventory. Management has stated a desire to purchase a greater amount of SUVs for its margins. However, while the industry has seen an 8% increase in SUVs and an 8% decrease in cars, CarMax's vehicle mix has stayed consistent with SUVs staying in the mid 20% of total inventory.

Second, CarMax Auto Finance will also experience headwinds from lower prices in two ways. First, interest revenue of the CAF segment should move with car prices. For example, if a price of a car decreases from $5000 to $4000, CAF loses growth because now it only receives interest payments on $4000. With prices projected to fall it would dampen the outlook for the growth of the company's CAF segment. Second, if prices experience a significant fall then some people will be paying off their loans on an underlying that is worth significantly less than before. Any defaults on these loans will cause distress in CAF, significantly affecting tier 3 subprime loans that that CarMax securitizes. Furthermore, as auto loan debt continues to balloon, delinquencies are also on the rise. CarMax's business with subprime borrowers, which should be its most profitable, is already being damaged by widespread concerns about subprime auto risk as well as regulations on Santander, which is one its biggest third party financers. The fees to transfer the risk have increased, hurting margins on the business, and it has become hard for CarMax to pass on costs to its customers with tier 3 decreasing from 14% to 9% of revenues.

We think that the market has misunderstood the potential severity of this incoming off lease cycle. The 2Q results has its fair share of warning signals. They still remain bullish due to growth numbers, but those numbers are inflated for two reasons. The increased same store comps may have increased due to a temporary economic moat. Carmax found a loophole to selling vehicles that should have been recalled due to the ongoing Takata scandal, which allowed it to attract more customers in the short term. Moreover, included in the same store sales was a growth in financing penetration, which would be hurt just as greatly if the catalyst plays out.

While the market has picked up the implications of the off lease cycle, discussions have been mainly about the retail business. We believe that the market has yet to factor in the discount on all future interest payments as a result of decreased used car prices. This series of catalysts will play out beginning at the end of 2016 into 2018. (The peak of lease originations plateaued in 2015). These catalysts should have played out before the growth benefits of new stores, which need time to increase margins, can be realized.

High Multiple Is Not Justified

As a result of the thesis, we see that CarMax's business model is not truly protectable in this competitive industry. Growth prospects are greatly dampened by industry cycles, and CarMax's economic moat of scale and variety may erode as the off lease cycle makes a great variety of vehicles to all industry players. Its margins will be hit relatively hard. Therefore, its current premium of 2x used retail auto industry is unjustified (auto finance usually trades at an even lower multiple). Direct competitors Sonic (NYSE:SAH) and Asbury (NYSE:ABG) trade at 10.11 and 9.18 EV/EBITDA respectively. Moreover, companies like Penske Automotive Group (NYSE:PAG) and Autonation (NYSE:AN), which have higher margins because of auto parts, trade at 12.53 and 9.83 EV/EBITDA.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.


The 7 Best Sites to Buy and Sell Your Car Online

The state of online car shopping is strong.

Selling leased car to carmax

Over the past few years I've used the following four online services to buy a car. Here's how it went, followed by three other options.

I bought my 1998 BMW M3 convertible on eBay. Lesson learned: Make sure it's such a good deal that you're okay with any foibles undisclosed by the seller. So how do you know you're getting a nice price? Do an advanced search and look at the completed listings. You'll see what sold. Maybe even more important, you'll see what didn't.

TrueCar is a great tool for removing the mystery of the MSRP. Say you want a 2015 Chevrolet Silverado 1500. 
For that truck, TrueCar has more than 10,000 actual -transaction prices that help you see what you should pay -(probably $2,000 under invoice). Be forewarned that if you do sign in and search a particular model, dealers 
will begin calling you within about three minutes.

This is an aggregator that covers a number of the popular car-buying sites. The key feature, though, is Craigslist aggregation. I used it to locate and buy a truck that ended up being 800 miles away. And manually searching an 800-mile Craigslist radius is a little masochistic even for hardcore used-car junkies.

Cars.com is useful simply because it's so huge that it quickly exposes outlier prices—both high and low—thanks to the national sample size. It's also great for finding leftovers, since you can search new cars and then sort by oldest first. Did you miss out on the Pontiac Solstice GXP back in 2009? Not to worry, Malouf Buick GMC in New Jersey still has a new one. Although they're evidently not in much of a rush to sell it.

360-degree views reveal features and flaws. Most cars are delivered the next day, with a seven-day test drive. If you live in Atlanta, pick up your car at the eerie but fantastic car vending machine.

If you're selling, Carlypso comes to your house, inspects your car, and installs a device that lets potential buyers take (authorized) test drives. ­Available only in California.

If your car passes a 185-point inspection provided by Beepi, it will list and sell it within thirty days or buy the car from you. Buyers get a ten-day money-back guarantee.

This story appears in the July/August 2015 issue of Popular Mechanics.

Want to hear more from Popular Mechanics? Check out our podcast, and subscribe and comment on iTunes!


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