President of DCG Acquisitions, Brian Brown, is featured on Market on Close.
What Do CarMax Earnings Mean For Automotive Sales?
CarMax has outperformed expectations recently, while operating with a business model that is not the traditional one for automotive sales. Let’s take a deeper look at CarMax as a company, as well as focusing on its most recent financial results. We will then look at the sustainability of the current state of automotive sales, where record dealer profits are combined with a very tight supply situation. We can then extrapolate some lessons that your dealership can take from the specifics of CarMax’s performance.
What is CarMax?
CarMax is a US-based used vehicle retailer that is made up of two primary businesses: CarMax Sales Operations and CarMax Auto Finance. The CarMax concept was developed by Circuit City executives in 1991 and started out as a division of Circuit City Stores Inc. After opening its first location in Richmond, Virginia in 1993, CarMax has grown to 237 stores in 41 states nationwide at the time of publication.
While CarMax deals exclusively with used vehicles at the present time, it was in the new car business for 25 years. After buying its first point in 1996, it acquired a total of 21 new-car franchises, of which the last was sold in 2021.
Why? CarMax decided to return to its original used-car roots exclusively, to focus on its core customers, and to add a seamless omnichannel buying experience (through several Customer Experience Centers) that caters to whatever level of remote purchasing each used vehicle customer prefers. This omnichannel approach is also a response to meet the challenge of the online used-car sellers like Carvana, Shift and Vroom.
The average CarMax store is around 60,000 sq. ft., with an inventory of up to 400 vehicles. It achieves an inventory turn rate of between eight and ten times each year with a staff of around 40 sales associates. CarMax puts each of its cars through a 125-point inspection process and offers:
- A 90-Day warranty
- 3 Days to change financing at no additional charge
- A 30-Day money back guarantee
Any vehicles which are unable to meet CarMax’s retail standards are wholesaled through CarMax auctions. CarMax’s other revenue sources include the sales of Extended Protection Plans to their customers and the operation of service departments.
During its most recent fiscal year, which ended on February 28, 2022, CarMax sold a total of 1,630,550 vehicles, of which 924,338 were retail and 706,212 were wholesale.
What are CarMax’s financial results for Q1 of 2023?
Let’s first review the good news for CarMax’s results for the first quarter of fiscal year 2023, which ended on May 31, 2022:
- Revenue increased 21% to $9.3 billion
- Gross profit per retail unit (GPU) was up $134 to $2,339
- Gross profit per wholesale unit (GPU) was up $4 to $1029
- The average used car price rose by $6,300 to $28,844
Now the bad news for Q1 2023:
- Used vehicle sales were down 11% compared to the same quarter a year ago
- Net earnings dropped by 42% compared to the first quarter of the previous year
- Finance income dropped 15.4% because of a higher provision for loan losses
- Operating expenses were up 18.5%
- Cost of sales increased 24.6%
- Gross margins dropped to 9.4% from 12%
What lessons can dealerships take from this situation?
CarMax is experiencing the same low-inventory situation that is affecting the entire auto retailing business. Both new and used car dealers are making more money by selling fewer units.
The year 2022 is forecast to be the highest profit year for dealers of all types. Even multi-generational dealers who have lived through the glory days of the 1950s through the 1980s have never experienced a marketplace like this one. It is truly an amazing time to be in the new and used car business!
How sustainable is the current state of automotive sales?
We are approaching the point where several factors are in the process of intersecting with each other. How this plays out will determine how sustainable the current price-raising model really is.
At the current moment, there appears to be two different types of buyers in the market:
- One group of buyers needs to replace their vehicle because the old one is no longer usable.
- The other group has money to spend and doesn’t really need a car, but definitely wants one and will purchase it regardless of the price.
Group #1’s trade-ins are reflected in the higher numbers of CarMax vehicles that needed to be wholesaled. These vehicles were too far gone and not suitable for CarMax’s lots. These buyers waited until the last possible moment to buy a replacement vehicle. If CarMax has had more of these marginal vehicles to deal with, dealers nationwide likely do as well.
Group #2, on the other hand, is likely to provide trade-in vehicles that are newer, fresher, and can easily be retailed for additional revenue by the acquiring dealer. These higher-quality used vehicles are supporting the current market for retailers nationwide.
The sustainability of this model hinges on how long the supply of new cars will be suppressed. The prolonged shortage of new cars has also evolved into a shortage of used cars. For new cars, 2021’s production of 15.4 million can be compared to the current predicted 2022 SAAR of only 13 million. Used cars sales of 44 million for 2021 are likely to decline to around 36 million in 2022.
We are seeing bigger shortages in both new and used than at any other time. If this continues, sales volumes could decline to the point where there may not be sufficient quantities of saleable inventory to offset these higher-than-normal prices. If and when that happens, the party may come to an abrupt end.
Additional factors may complicate the current situation
While the existing microchip shortage and supply chain issues facing the industry will not be relieved quickly, there are some other issues which could weigh upon the sales outlook going forward. These include:
Higher prices and inflation: For CarMax and other retailers, the cost of inventory has risen sharply due to shortages, leading to higher retail prices. These high prices have led to slowing sales among price-sensitive used car buyers. Inflation and raw material price increases are already affecting new car prices, in both the internal combustion and electric vehicle segments.
Higher interest rates: The Federal Reserve is raising rates to cool inflation. This will increase monthly payments and make vehicle purchases less affordable.
Consumer confidence may drop in anticipation of a recession: There is already a significant group of potential customers who have chosen to “sit out” the current tight-inventory sales environment. Their cars are in good enough condition to keep driving for a while, or else they have had a mechanic fix up their vehicles so that they will last a bit longer. Now that there is the possibility of a recession, additional consumers may choose to “keep their powder dry” and wait until the economy improves.
There is good news
Let’s focus on the good news in the recent CarMax report. Its profits are solid and its cash flow is strong. It has a large inventory of good quality used cars, which is a very good thing to have for growing market share. Its omnichannel strategy is working, with digital sales increasing to 11% of its total, as opposed to its year-ago number of 8%.
What can dealers learn from CarMax’s recent results? Here are some takeaways:
- Continuously build up your good-quality used car inventory
- Wholesale any vehicles that are below your minimum standards
- Strengthen your online sales capabilities
- Thoroughly inspect your used cars and let your customers know
- Offer a solid basic used car warranty with a money back guarantee
- Provide reasonably-priced extended protection plans
- Price your used cars in line with the market to maintain market share
CarMax has built a solid national reputation for itself and has taken a unique approach to selling used cars. Keep in mind that even if there is not a CarMax store near you, you may be competing for used car sales with CarMax online – just as you are competing with Vroom, Shift, and Carvana.
DCG Acquisitions is here for you when it’s time to buy or sell
For everything that’s involved in selling or buying a dealership, DCG is here for you! DCG is one of the country’s leading, and fastest-growing, automotive M&A firms. We pride ourselves on our network of connections — with automotive manufacturers, financial lenders, dealership buyers and sellers, and more — that help us create a qualified, competitive environment on both sides of the sale.
Contact DCG Acquisitions to speak directly with an Automotive M&A specialist and learn how our expertise can help you get the most out of your next dealership purchase or sale.