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September 01, 2020 1:29pm
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CarMax: A Market Melt-Up Waiting to Happen for this Stock

CarMax (NYSE: KMX) is set up for a market melt-up because of improving market sentiment. The used car market is still struggling due to market normalization, but it is sufficient to drive solid cash flow for this business, and the trends are improving. The critical takeaway from the Q1 report is that costs are improving, vehicle value is stabilizing, demand is rebounding, and the business is set up to return to growth with leveraged earnings power. 

Among the drivers for the melt-up will be short interest. CarMax is among the most heavily shorted S&P 500 (NYSEARCA: SPY) stocks, with a short interest of 12.5% at the start of June. Since the price action in June leading up to the earnings release is not bullish, it points to an increase in short interest, not a decrease. CarMax may not be primed for a short squeeze, but short-covering will add momentum to the rally. 

Better Than Expected Results Are Why CarMax Moves Higher

CarMax struggled in Q1, with volume and pricing impacting the top and bottom lines. However, the company’s $7.11 billion in revenue outpaced the consensus reported by MarketBeat despite the 7.5% decline. The critical details are that the revenue was slightly better than expected and aided performance on the bottom line. Regarding units sold, total units fell by 5.3%, while used same-store comparable sales fell by 3.8% and wholesales by 8.3%. 

Margin news is mixed. The company improved margins in all segments, with wholesales and EPP setting records. The bad news is that one-offs in the prior and current years led to a decrease in GAAP earnings, but the decline is less than expected. The $0.97 in GAAP earnings beat by $0.02, leaving cash flow in fine shape. Cash flow is down compared to last year but sufficient to improve the balance sheet while returning capital to shareholders. 

At the end of Q1, the balance sheet highlights include a reduction in cash and current assets offset by increased total assets, reduced debt, reduced liability, and a 5.6% increase in shareholder equity. Share repurchases were accelerated in the quarter, and shareholder value was impacted. The company repurchased $104 million or about 1.4 million shares, reducing the count by 0.5% on average. Because the outlook for sales is stabilizing, with growth expected to return by year’s end, and there is still $2.26 billion authorized for repurchases, aggressive buybacks will likely continue. 

CarMax Has An Edge With AI 

CarMax was recently called out by The Goldman Sachs Group (NYSE: GS) as a consumer discretionary company best positioned to benefit from AI. In their view, AI could drive 42% of earnings growth from the baseline outlook, which includes modest growth this year, which will accelerate to over 25% next year. Assuming that CarMax’s 24x multiple of this year's EPS outlook is accurate, this stock could rise by $20 or 27.75% over the next year on a simple price-multiple expansion. Add in the outlook for productivity gains, and the potential for gains is amplified.

The eleven analysts tracked by MarketBeat have a consensus of Hold for this stock and are narrowing the target range for its price. This shows a deepening conviction the stock will rise by 7.5% over the next few quarters. 

CarMax Stock Price Bottomed and is Set Up to Rebound 

CarMax’s stock price corrected following the Q4 earnings report but quickly bottomed. The market is moving within a trading range and now shows support above the range’s low end. The post-release action has the market up, suggesting a reversal is in play, but there is a risk for bulls. The market also shows resistance at the middle of the range, which may be sufficient to cap gains. In that scenario, this market will continue to move sideways within its range, with a possibility of retesting the low end. If the market can sustain upward movement and move above $72.50, it could quickly advance to the $87 level. 

CarMax KMX stock chart

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