OT: KMX

I view the current drop of about 0.6% from prior norms to be transient.

“Transient” should be enough to scare investors away. :slight_smile:

The SGA as % of Gross margin is pretty high and this quarter is definitely outlier.
4Q-21 4Q-22
Gross Profit 641 711.00
SGA 556 675
86.7% 94.9%

Is there a way this will come down in future, not just back to normal but in a sustained way? Currently it is way above 80%+, can it come down? How online sales will impact this?

If there is a way to bring it down below 70%, that is a huge driver for net profits.

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Does the financial arm of the KMX become an issue during rising interest rate? The default rates are sure to rise as interest rates go up. I am not sure what is the debt on the financial arm of the company but balance sheet shows total debt of $13B. So a percent rise in rates can be meaningful.

I’ve been taking a closer look at CarMax and this is one of the big questions I had as well. Finally, opened a biggish position today, thought I share some of my notes.

Q: CarMax’s long term debt structure?

  • Roughly $18.1B made up of $14.8B non-recourse debt for financing operations, $2.6B long-term debt, $0.5B operating leases.
  • Non-recourse debt is related to their CarMax Auto Financing operations, made up of a warehouse facilities (~20%, variable, usually 1 year term) and asset backed term funding (~80%, fixed). Usually starts off with warehouse facilities until they do an issuance of an asset backed securitization (see for previous prospectuses https://investors.carmax.com/financials/financial-informatio…). As expected, the non-recourse loans only have legal claims on the underlying vehicles they fund and related receivables and reserves.

Not much long term debt to be concerned about (~$3B) vs. FY2022 profit of $1.2B

Q: Credit / Interest rate risk?

  • Portion of variable rate warehouse loan hedged with interest rate derivatives
  • Most financing is done with fixed rate; asset backed securities are fixed rate
  • Usual risks associated with access to credit market and usage of derivatives / counter parties
  • Aim for losses in 2% to 2.5% range (FY 2021 annual report)
  • Mention (2021 annual report) that a 100-basis point increase would have decreased eps by $0.11 (vs. $6.97 eps for FY2022).

In a worse case credit crunch scenario, they theoretically could stop writing auto loans (and instead rely more heavily on other banks to finance, which is a portion of their financing) but you would expect that to affect sales. Moreover, the economy would be bad lowering demand and other financial institutes probably would not want to finance these types of loans.

Q: Inventory risk?

  • $4.6B in inventory (as of Q3)
  • COGS (trailing 12 months) = 21.6B + 4.5B = $26.1B
  • Inventory turns = 26.1B / 4.6B = 5.6

Seems like they can turn over inventory relatively fast. If they needed to, they probably could cut prices to clear inventory faster. And they can slow down inventory purchases if they see headwinds. Not too much to be concerned about.

Q: Performance in bad economy?

  • Peak used car sales were in 2005 at roughly 43M vehicles, lowest in 2008 (36M) and 2009 (35M) with 2019 at 40M (below peak)
  • 2008 saw biggest drop in used car sales ~12%, CarMax revenue dropped ~15%
  • Despite the dip in (calendar) 2008/2009, hit new revenue high in 2010 with remarkably consistent growth over 2003 - 2019 even with the 2008/2009 recession
  • CarMax has 4% market share in FY2022, projecting 5% by FY2026
  • Source: https://www.bts.gov/content/new-and-used-passenger-car-sales…

CarMax has done extremely well even though the used car market despite relatively flat growth. Indicates CarMax is mainly growing by taking more market share. If the economy did poorly, they would be hit but probably along with all the other used car dealers. Their revenue growth despite flat overall market shows that their product/service is delivering something valuable.

An interesting note is that they acquired Edmunds.com in 2021 (with a minority stake and partnership before that). The data in the linked source uses Edmunds data from 2010-2019. A small part of this story is that having that additional data through Edmunds across the used car market is a competitive advantage for pricing used cars and giving out loans. In the annual report, they explain that they use “advanced data science and machine learning capabilities” to optimize their business and customer experience. I looked through a few of their job openings and they seem pretty reasonable for what I would imagine CarMax needs. Although not a big part of the story, it’s good to know they are likely staying on top the technology.

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I’ve been taking a closer look at CarMax and this is one of the big questions I had as well. Finally, opened a biggish position today, thought I share some of my notes…

Nice notes, thanks.

For fun, I thought I’d see what some of the “bot” analysts think of it.
Zacks has it as a category 5 “strong sell” and an F ranking for growth.
Yet their expectations of business results show a forward P/E of 13.84 and forwards 3-5 year EPS growth of 15.63%.

FWIW, I don’t get the “F” for growth.
Nnet income up in last 1/2/3 years at compound rates of 54.1% / 13.8% / 11.0%
Because of changing share counts, EPS per fully diluted share up 13.3%/year in last 3 years.
Auto finance income has almost doubled in that time, rising from 39% to 54% of pre-tax income.
Which one might see as good or bad depending on whether you’re a worrier or not.

Jim

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<<Auto finance income has almost doubled in that time, rising from 39% to 54% of pre-tax income.
Which one might see as good or bad depending on whether you’re a worrier or not.

What’s the financing debt to collateralized asset ratio? That’s important for determining whether CarMax would lose money if a loan is defaulted.

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After doing DD, reading the comments of those I respect and admire here and using some TA, I started an opening position today (1/3 position). One thing that bothers me, if Yahoo is correct, is the low insider ownership.

Several past encounters with multiple KMX dealers for my 4 daughters, have been very pleasant for me. I ended up buying new cars from another dealer for them.

Recently, someone I know of, with very poor credit and an unstable employment history, was able to buy a car through Carvana (CVNA) but couldn’t through KMX.

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As a “customer”, I’ve found KMX to be outstanding. Of course, I tend to be a good customer. I don’t lie about what’s being sold or forget to pay for what’s being bought.

As a “shareholder”, I’m a believer in a simple business concept that faces some competitive pressures but is generally well run and relatively cheap from an absolute PE basis level.

KMX’s PE is roughly 12.5x. If the earnings yield (1/12.5=8%) is indicative of the return (give or take inflation), I’ll be plenty happy. If Mungo’s right and we see a near-term pop bringing annualized return to 10%+, I’ll be exhuberant.

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Not that is matters much but Thomas Gayner - Markel Asset Management used to have a big position (his second largest for a while) in KMX and they started lightening up and sold out in 2020. I usually like confirmation bias – seeing others that I respect buying the same things I am looking at. Lots of reasons to sell and you can never step into the same stream twice (2020 vs 2022) but I found it curious that he sold. I wonder if he ever commented on that in an AM?

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bankersfate, you wrote:
I found it curious that he sold. I wonder if he ever commented on that in an AM?

He commented in a blog…here is the transcript link:
https://ritholtz.com/2021/11/transcript-thomas-gayner/

(excerpted)

Let’s talk a little bit about some of your favorite companies. You have some holdings. And when I look at some of your top five or top 10, there are almost nothing like each other. There — there’s just a mix of companies, CarMax, Disney, Berkshire, Amazon, Regeneron, and then a whole bunch of investing firms, BlackRock, Federated, Oak Tree, T. Rowe. Am — have I named anything that you’ve jettisoned since or …

GAYNER: Oh, actually, you know, Oak Tree is — is no longer with us. That’s part of Brookfield Asset Management, which is our second largest holding that we have. And we are no longer owners of CarMax.

RITHOLTZ: Oh, you sold CarMax, which had a huge run-up …

GAYNER: Correct.

RITHOLTZ: … given the craziness with supply chain. And I think, at a certain point, that just became fully valued. I’m going to guess …

GAYNER: Well, no, and I would — I would admit an error on my part in this. And, in fact, the — the gentleman who runs CarMax — the CEO — I mean, we’ve owned it for a long time, but it had been absolutely a great holding. When we sold it, I called him and I said, “Bill, that — that was our circumstance, not yours.” CarMax is a great company. It’s very well-run. I have epic respect for what they do. We enjoyed being a shareholder for — for a long, long time.

When we go back to the initial days of the pandemic and the shock losses from event cancellation insurance …

RITHOLTZ: Sure.

GAYNER: … business interruption, which was uncertain, in the first quarter of 2020 — I lose track of years …

RITHOLTZ: Yeah, same.

GAYNER: … and time these days, you know, we reported a combined ratio of 118. So as compared to our historical record of underwriting profitability where that combined ratio number would always be below 100, 118, that is the worst period Markel Corporation has endured in 90 years of existence.

RITHOLTZ: Wasn’t a great quarter.

GAYNER: It was not a great quarter. And the model where we are using the profits from the insurance company to create the flow — to create the (inaudible) …

RITHOLTZ: Now you’re reversing that.

GAYNER: … exactly. So, jet engines don’t fly in reverse.

RITHOLTZ: Right.

GAYNER: That jet engine was flying in reverse during the first quarter of 2020. As such — and I think even independent of that, there — there were kind of a combined set of forces at work where, look, we got — we got to make sure that the insurance business is on firm capital footing. It’s a regulated business.

RITHOLTZ: Sure.

GAYNER: And we always want margin of safety and margin of error, that humility. Look, let’s — let’s not pretend we’re the smartest. So, if we were the dumbest, what do we need to do to protect ourselves from us …

RITHOLTZ: Right.

GAYNER: … to make sure we keep going? So, we would’ve re-underwritten and as usual, we did. We’ve re-underwrote every single security we’ve worked. And, by the way, in that environment, we also re-underwrote our thinking on every insurance policy. We wrote because it was clear that this was a fundamental change that — that had overtaken all of us. So, let’s make sure that we’re adaptable and thinking that we’re able to answer the bell for the next round of the fact.

So, in looking at each and every security that we owned and recognize — and look, I want to take a little money on the — off the table, and I wish to make sure that the capital footings are impeccably sound and — and unquestionable. Looking at each and every one, among the decisions that we decided to sell was — was CarMax. And I thought, you know, at that point in time 50 percent locations were closed, who needs a new car? Who needs a used car? Well, it turns out everybody did.

RITHOLTZ: Right.

GAYNER: But I did not foresee that coming. And just given the time and facts of the — the — the circumstances, there were — there were several things we sold at that point. In retrospect, they all went up and they all went up a lot …

There’s a lot of other good stuff in this link too : )

tairbear

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Great post Tairbear. It is so important to understand the Buffett and Gaynor run businesses and invest related to that and not as individuals. I’m pretty sure that only 1% of Buffett followers ever think about this.

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It is so important to understand the Buffett and Gaynor run businesses and invest related to that and not as individuals.

Buffett the stock picker is someone I can recognize and admire. Where do you see the businessman?

Well said, Chompin. I changed my handle from 1kali to beginner3388 because I forgot that.

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Reminds me of this terrific WEB commentary from the 2020 meeting. He may be the greatest risk manager of all time as well:

“20. Why Berkshire will always have “plenty of cash”
WARREN BUFFETT: And if we’ll go to part two — we at Berkshire, we keep ourselves in an extraordinarily strong position. We’ll always do that. That’s just — that’s fundamental.

We insure people — we’re a specialist to some extent, and the leader — it’s not our main business — but we sell structured settlements. That means somebody gets in a terrible accident, usually an auto accident, and they’re going to require care for 10, 30, 50 years.

And their family or their lawyer is wise enough, in our view, that rather than take some big cash settlement, to essentially arrange to have money paid over the lifetime of the individual to take care of their medical wills — bills — or whatever it may be.

And we’re — we’re a large — we’ve got many, many, many people that, in effect, have staked their wellbeing on the promises of Berkshire to take care of them for, like I say, 50 years or longer into the future.

Now, I would be — I would never take real chances with money under — of other people’s money — under any circumstances. Both Charlie and I come from a background where we ran partnerships. I started mine in 1956 for, really, seven, either actual family members or the equivalent. And Charlie did the same thing six years later.

And we never — neither one of us, I think — I know I didn’t — I’m virtually certainly the same is true of Charlie — neither one of us ever had a single institution investment with us. I mean, every single bit of money we managed for other people was from individuals, people with faces attached to them — or entities — or money with faces attached to them.

And so, we’ve always felt that our job is basically that of a trustee and, hopefully a reasonably smart trustee, in terms of what we’re trying to accomplish. But the trustee aspect has been very important. It’s true for the people with the structured settlements. It’s true for — up and down the line. But it’s true for the owners very much, too. So we always operate from a position of strength.

Now, I show on — on the slide that’s up, I show our — well, let’s go back one. Yeah. I show our net — our cash and Treasury bill position on March 31st. And you might look at that and say, well, you’ve got 125 billion or so in cash — in Treasury bills. And you’ve got, at least at that point, we had about 180 billion or so in equities.

And you can say, well, that’s a huge position, having Treasury bills versus just 180 billion in equities.

But we really have far more than that in equities because we own a lot of businesses. We own a hundred percent of the stock of a great many businesses, which to us are very similar to the marketable stocks we own. We just own them all. They don’t have a quote on them.

But we have hundreds of billions of wholly-owned businesses, and so they are — 124 billion, that’s not a — not some, you know, 40 percent or so. The cash position is far less than that. And we will always keep plenty of cash on hand and for any circumstances.

If a 9/11 comes along, if the stock market is closed as it was in World War I —it’s not going to be, but you know, I didn’t think we were going to be having a pandemic when I watched that Creighton-Villanova game in January either, so —

We want to be in a position at Berkshire where — well you remember Blanche DuBois in “A Streetcar Named Desire” — that’s goes back before many of you — but she said she didn’t want to — she, in Blanche’s case, she said that she depended on the kindness of strangers. And we don’t want to be dependent on the kindness of friends, even, because there are times when money almost stops.“

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Last year, amid supply chain shortages, production of new cars slowed. This created a huge demand for used cars, and prices surged. CarMax opted to hold its gross profit dollars per vehicle flat in this environment, which benefits customers. If historically CarMax sold a used car for an average price of $21,000 with a $2,100 gross profit, in 2022 it sold used cars for an average price of $29,000 with a $2,200 gross profit.

This decision was not well-received by Wall Street. In fairness to the critics, CarMax faced inflationary costs in wages and other areas that may have justified charging higher mark-ups. Still, CarMax sold 23% more vehicles in 2021 than in 2020, earned a lot more money and grew its market share to 4% of all transactions for used cars under 10 years old, from 3.5% a year ago. Presumably, the decision to price responsibly won it some customer goodwill that will result in future business.

https://seekingalpha.com/article/4503467-giverny-capital-car…

I remember Wall St used to be very critical of Costco for holding margins at 12%. One leading analyst gained quite a lot of fame for stating Costco was great for employees and customers but not very good for shareholders. This was in the days of Chainsaw Al and the peak LBO and cost cutting and maximizing short term profits was preached in MBA programs and Wall St. Luckily for me it gave me a great entry point into Costco, my second best investment after Apple.

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KMX’s PE is roughly 12.5x. If the earnings yield (1/12.5=8%) is indicative of the return (give or take inflation), I’ll be plenty happy.
If Mungo’s right and we see a near-term pop bringing annualized return to 10%+, I’ll be exuberant.

Still OT

FWIW, another “automotive adjacent” firm I quite like is LKQ Corp, which is also making money hand over fist while being cheaper than its historically usual level.
It’s a jumped up wrecking yard, to an extent: They mostly sell car parts, mostly used, mostly in Europe and the US.
A division selling specialty parts for RV, off-road, performance etc. Some related services.

Though it doesn’t tell the whole story, trailing P/E averaged about 35 during 2013-Q4 when it was fashionable, and is now 13.6. (11.7 times 2023 consensus)
Yet earnings have risen so much, someone holding since then has still made a return of +5.3%/year.
The rise in earnings has been a steady juggernaut, other than a non-cash impairment charge in 2018 that creates a dip in headline EPS.
Strong balance sheet, falling share count, steady earnings growth, EPS expected to grow in solid double digits for years yet, blah blah blah.
And a 2.0% dividend yield if you like that sort of thing, which started just last year.

I suspect someone buying today (close $49.87 yesterday) and forgetting about it for a few years might be reasonably pleased.
The share price ought to double soon enough to make a fine annualized return.
Apologies for not having posted at the March lows : )

Jim

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Btw, at a Markel event in Omaha Tom Gayner was asked about selling KMX which was their #2 position and he confirmed it was out of genuine concern of the extreme downside possibilities from COVID. He responded positively that They certainly continue to follow the stock and that there is a distinct possibility that they may purchase it again in time. So it sounded like there were no strong concerns, it was just an asset that they felt they needed to liquidate for coverage and cushion for their operating companies. I spoke with one of the higher up Markel colleagues and he speculated that Tom probably would not sell if he had a do over. Made me feel even better holding the position.

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I was at Omaha and didn’t think to stay long enough for the Markel event…

Do you know if this was recorded?

Yes it was recorded and I imagine there would be a link thru their website soon but I did not ask. Lasted 2 hours and there were over 500 in attendance. I liked all that I heard and the 3 prong approach parallels BRK so well as well as the integrity and ethos. Ventures is growing nicely with 2 new acquisitions and feels under appreciated. Funny, when asked about Markel’s less heavy equity positions at the top, he said breaking news: “I am not as smart as Mr. Buffett!” He went on to mention their top 20 positions still make up 2/3 of the equity positions value so still pretty too heavy.

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My day job happens to be in a similar industry (not autos) so this interested me enough that I downloaded their “Factsheets” to see what information they provide. The “Unit and Per Unit” file has some excellent historical data in it if anyone is interested. I added in their store count over time and, like others have said, they appear to be a flow business. Their ability to turn inventory and execute is really quite impressive and I don’t see the Carvanas of the world having much of an impact on them because this is still a location driven business.

Per store retail used vehicle sales for fiscal 2022 were just slightly above average at 4100 units/store. They grossed about $2.1k per new retail and have been getting roughly that same amount for over ten years.

Wholesale unit sales per location were over 3100 units/store and up over 20% from their average of 2500 units/store. They did manage to wholesale 3000 units/store in their fiscal 2012 coming out of the financial crisis. They grossed about $1080 per wholesale unit this year which is about 13% higher than their long term average. I think both numbers will come down as the insanity in the US car market goes away. In an average year they wholesale about 0.60 units for every used retail and this year they were over 0.75. They wholesaled just over 700k units last year and I’d guess that normalizes to something like 600k this year.

Per store net income seems to have averaged roughly $4M/store for the last ten years at an amazingly steady state. Their fiscal year ending February 2022 was $5.1M/store. That was a huge increase and one I think they will have difficulty matching this year. My best guess is they revert to something closer to $4.5M/store, increase their store count to 240 as stated this year, and net income falls -5% to -6% for the full year.

They have the approved share repurchase amount (~$1.2B)to easily buyback 6-7% of the company this year, which they have proven they are willing to do several different times in the past. They seem committed to using repurchases to deliver EPS growth in the 15% range over time. It might be a challenge to grow EPS at that rate this year coming off the high from last year but I don’t see any reason they can’t back to that rate over the next 2-3 years.

I’m going to sit back and wait for their Q1 numbers before I buy much. I’ll likely end up being wrong but there are always opportunities somewhere.

Jeff

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My day job happens to be in a similar industry (not autos) so this interested me enough that I downloaded their “Factsheets” to see what information they provide…

Thanks for the thoughtful comments.
Much appreciated.

On the more meaningless short term price front, a wild speculation: looks like perhaps Mr Market might think they’ve bottomed.
Up 3.5% more than the average S&P 500 firm today.

Jim

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looks like perhaps Mr Market might think they’ve bottomed.

Appreciate the thanks. I’m just trying to repay the knowledge I’ve benefited from over the last 20+ years lurking around here.

Mr. Market does seem to like to give them a 20PE fairly regularly so the bottom might be in. Their used retails looked like they were starting to slip a little in Q4 but wholesale was still strong.

It’s funny because I initially just started looking for their inventory turn info to see how they might weather a downturn. I didn’t find good per unit info but as best I could tell they are turning inventory a little over 6x and that led me to stumbling on the Factsheets. I don’t think they can push the turn much higher considering the time needed to prep a vehicle for sale, get it marketed on their website, transfer if needed and get the deal closed. Once I found the historical unit data and the consistent $2k gross per retailed unit over a decade I’m confident inventory won’t be much of an issue for them. Worst case they likely take a slightly lower gross for 3-4 months to burn down the over priced inventory and then they’re back to $2k/unit again like clockwork.

I would bet they have a hard policy once a unit has been listed for about 60-90 days it’s immediately moved to wholesale. That sounds ridiculously simplistic but you would be amazed how easy it is to fall in love with inventory just KNOWING the market will turn and you can make that margin back in the near future. Or how hard it is for a sales manager to let a piece go to wholesale when a salesperson is just SO CERTAIN they have a customer that all of a sudden wants it after sitting on the lot for 6 months. And of course that customer rarely comes through and 6mo becomes 9mo and you just spent another 1-2% carrying it. It would be really interesting to talk to one of their location managers to understand how they try to remove the emotion out of it.

I briefly glanced at their captive finance operations from the last annual report and didn’t see anything alarming. What I would consider high interest rates on their car loans maybe, but they are dealing in the used market so probably not surprising. I didn’t see any auto leases identified on their books so they haven’t fallen into that trap of sorcery at least. Their “Other” gross profits per unit seem just as steady as their retail and wholesale profits so I’m betting they are conservative on that side of the business too and just using it to keep the inventory moving. I’ll take a deeper look sometime and share if I decide to make a meaningful share purchase.

Jeff

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