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Stock Analyst Update

Buybacks and Tax Reform Are Good News for CarMax

The quality of the fiscal first-quarter earnings isn't extraordinary.

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 CarMax (KMX) reported fiscal first-quarter 2019 results that received a lot of help from continued share buybacks and the new lower U.S. tax rate. We do not see a reason to change our fair value estimate. Diluted EPS increased by 17.7% year over year, but we calculate a 13% increase excluding $207.4 million of buybacks during the quarter at an average share price we estimate at $62.85. Management rightly pointed out in the release that EPS growth came from the tax law change lowering the company's effective tax rate to 25.3% in the quarter compared with 37.4% in the prior year's quarter. Although we think CarMax's profit numbers and adjusted free cash flow were good (the latter grew 28% by our math) and EPS and revenue did comfortably beat consensus, we think the stock increasing over 13% on the morning of June 22 is overdone because the quality of earnings are not extraordinary in our view.

Used unit comparable store sales fell by 2.3% year over year but did improve from fiscal 2018 fourth quarter's horrible minus 8% figure. According to our data, CarMax had not posted consecutive quarterly negative comparable unit store sales since fiscal second and third quarter of 2012. Management for first quarter cited continued macro pricing factors weighing on comps, which we interpret to mean store traffic fell because of attractive incentives in the new vehicle market. Used vehicle pricing however remains high due to tailwinds from low supply following last fall's hurricanes. CEO Bill Nash told us that he expects the continued higher supply of used vehicles (we assume he meant due to higher off-lease volume) to eventually drive used pricing down, which we are also expecting. This change may help reverse the negative comparable sales as more shoppers may choose a used vehicle over new as pricing falls. CarMax's ASPs rose by 3% to $20,067 while total unit sales rose by 1.6% thanks to 18 new stores, or a 10% rise in the store base, since the start of the prior year's quarter.

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David Whiston does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.