CarMax Slides On Earnings Disappointment, Time To Celebrate?

Many investors are familiar with that uneasy feeling you can get in the pit of your stomach when a stock dives after a bad earnings announcement. It may still be a great brand and business, but this temporary - hopefully temporary - blip in the chart is often enough to send potential buyers running for the door.

An example of this is what investors are experiencing after a dismal sell-off in CarMax NYSE: KMX shares. The stock has declined by as much as 13.1% during the past few days. The reason behind the decline is a mix of a somewhat disappointing earnings announcement and a market-wide decline during the same period.

The truth is that analysts and markets are still relatively bullish on the future of this stock, as it is one of the best-positioned platforms to manage through the current turbulence in the American automotive industry. 

The Fuel Behind the Sell-Off

Financially, bears have a valid point behind riding this stock as low as they have. However, this effect may be exaggerated. More on that later. First, let's look at the main drivers of the business because these are the metrics setting the market sentiment.

For starters, net revenues declined by 13.1% during the year, and retail unit sales contracted by 7.4%. These declines have a double effect: less volume, accompanied by lower values per sale due to depreciating car prices, has brought negative results.

However, the chaos that caused the decline in car prices and the lower sales volumes was the same force behind CarMax's increase in gross profit per unit. This quarter, gross profit per unit was $963, representing an $82 improvement from a year ago.

Considering the company's current unit buying strategy, management is giving out implications that the recent contractions in the industry are far from over. CarMax purchased 292,000 units this quarter, which is 14.9% lower than last year. That's a clear sign that the company is waiting for better prices to acquire units.

The contractions are extending past the traditional dealer role in vehicles, as the financial segment "CarMax Auto Finance" also displays some potential cracks. Income from finance declined by 26.2% over the year, driven by a higher provision for loan losses. This makes sense considering today's environment. Interest rates have nearly tripled during the period, making financing a vehicle almost unattainable for most consumers.

With recession concerns rising and higher unemployment looming, perhaps management is just hoping for the best and preparing for the worst. That's not a terrible plan.

Now, the Not-So-Ugly Side

Keeping an ear to the ground, analysts are sounding off their contrarian sentiment about this stock.

With a consensus price target of $77.8 assigned to this stock, there is an implied 13% upside from today's compressed prices. Moreover, analysts expect a not-so-modest jump in EPS of 26.4% for the next twelve months.

All else being equal, stocks should behave similarly to underlying EPS since it is one of the leading financial metrics driving valuations. Therefore, this gap between expected EPS jumps and price targets creates a valid opportunity for those willing to go against the grain.

There is another echo sounding against investor sentiment, not from Wall Street but from inside the doors at CarMax. Management has stated its intention to resume stock buybacks during the third quarter of 2023.

Why are buybacks vital to you? As a shareholder, you will eventually own a larger piece of a - hopefully - growing pie. But there are other, more abstract, benefits to stock buyback programs.

By being willing to allocate company capital to repurchase its stock, management is telling the world that the stock is not only cheap today but that the overall view should be higher than it currently is.

Remember one thing: management hinted at repurchasing the stock the morning it sold off, implying that they already thought it cheap even before the 13.1% decline.

But analysts and management are not the only players seeing the value play within CarMax; other, more prominent players have already put their skin in the game recently. Barclays NYSE: BCS just upped its stake in CarMax stock by a massive 60.4% during the past quarter.

How can you beat the house? You don't have to be the fastest swimmer to escape the shark; you can swim faster than the guy behind you. In this scenario, you could consider buying CarMax at prices lower than Barclays and insiders thought made the stock a good deal.