Investing Into a Reformed Car Salesman
Joshua is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Society does not have a very positive image of a used car sales men. They seem be the epitome of sleazy, self-centered, opportunistic salesmen who are willing to sacrifice the customer in order to make a marginally better commission. Carmax came along and decided to try and change the used car business. Their cars come with a fixed price so the customer does not have to worry about haggling with any pushy salesman. Used cars are a huge business and this innovative sales technique has helped to set Carmax apart. Peter Lynch famously stated "invest in what you know" and I think most investors and car buyers would appreciate not having to endure a stressful sales process.
CarMax (NYSE: KMX) started in the early nineties as two circuit city executives decided to branch off into a new retail market. By focusing on quality used vehicles and a higher quality selling experience KMX has developed their own niche within the industry and now has over $10 billion in revenue over the last trailing twelve months. KMX's return on equity of 13.8% and total debt equity ratio of 1.85 are not the best numbers in the industry. Additionally, their return on invested capital is the second lowest only to KAR Auction Services. On a positive note Car Max has a gross margin of 4.0% which is relatively healthy. The company focuses on used cars but these are not $1000 clunkers which are just waiting to break down. KMX's business is very attractive but their relatively low return on equity and relatively high debt load give cause for concern.
KAR Auction Services (NYSE: KAR) is involved in different segments of the auto industry from insurance auto actions and salvage auto auctions to its auto finance operations. Their overall profit margin of 4.3% and free cash flow yield of 10.9% are encouraging. At the same time their return on invested capital of 2.6% is very low and calls into question the fundamentals of their business. KAR is expected to post a strong EPS growth rate of 28.0% in 2013, but with such a low ROIC and a PE ratio of 29.6 this growth ought to be taken with a grain of salt.
America's Car-Mart (NASDAQ: CRMT) operates a financing operation and a number of dealerships throughout the Southern part of the Midwest. A gross margin of 42.3% and a return on equity of 17.8% paint CRMT in a very positive light. Their balance sheet is healthy with a low total debt to equity ratio of .47. Their profit margin of 8.2% is also the healthiest within the group. CRMT does not offer the same unique sales process of KMX but their numbers show that regardless they have managed to carve out a strong position within the South and Midwest.
AutoNation (NYSE: AN) operates a number of dealerships throughout the United States. The majority of vehicles which they sell are new but used car sales are still a significant portion of their income. Their parts and service segment is the biggest contributor to gross profit. The gross margin of 16.3% and return on equity of 18.5% are reasonable, but their profit margin of 2.0% is abysmal. AN's PE ratio of 16.5 is significantly less than KAR's 29.6. With AN's low margins a low PE ratio appears to be well deserved.
KMX Free Cash Flow Yield data by YCharts
KMX Return on Invested Capital data by YCharts
Conclusion
Carmax has a very effective value proposition as their set prices reduce the amount of stress for the car buyer and make the purchase experience more tranquil. At the same time their total debt to equity ratio of 1.85 is high and their return on invested capital of 5.5% is on a downward trend and already relatively low. As an investment CRMT is a better option with their low total debt to equity ratio of .47 and high return on invested capital of 16.0%. CRMT does have a negative free cash flow, but it continues to post strong EPS and revenue growth. They have a very concentrated foot print and there are many local markets where they can expand into. Investing is not simple but a quick look at the numbers can help to weed out the weak from the strong.
MrCanadian1 has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!
