CarMax, Inc (KMX): A Defensive Investment In The Auto Industry

There are several ways that one can invest in the auto industry. The most obvious is through one of the automakers, like General Motors Company (NYSE:GM). You could also buy shares of a company that sells parts and accessories for cars, like AutoZone, Inc. (NYSE:AZO). A less obvious play, and one that I would like to explore today is a used vehicle retailer, CarMax, Inc (NYSE:KMX), which operates a network of about 120 used car superstores.

Why CarMax?

CarMax, Inc (NYSE:KMX) is a way to play the auto sector somewhat defensively. While automakers tend to do very well in good economic times, used car dealers tend to do well in both good and bad economies. In good economies, more customers are able to afford to buy a used car that wouldn’t have been able to in worse times. In bad economies, a lot of customers who would prefer to buy new cars are forced to cut back on their spending and buy used, more affordable cars.

A Little Bit about the Company

CarMax sells primarily used cars; however, the company has added new car sales at a few of their locations. They also provide their own financial services through CarMax, Inc (NYSE:KMX) Auto Finance.

The company made a name for itself with its “no-haggle” price model, which consumers who despise used-car shopping embraced. CarMax, Inc (NYSE:KMX) won customers with its promise that the price tag in the window was “the” price; there was no need to play the normal games associated with negotiating for a used car.

As well as CarMax has done over the years, there is still room for growth, and the market seems to acknowledge this with its valuation of the company. Despite being the largest used auto retailer in the U.S., CarMax only accounts for about 2% of the total used vehicles sold by dealers, leaving plenty of room to take market share from the traditional dealers, who, lets face it, many prospective car buyers dread having to deal with.

CarMax, Inc (NYSE:KMX) trades at a relatively high valuation of 25 times TTM earnings; however, this actually seems quite reasonable considering the growth potential of the company. The consensus calls for earnings of $2.08 per share for the current fiscal year (2014), and this is expected to rise to $2.33 and $2.67 in 2015 and 2016, respectively, for a 3-year average annual earnings growth rate of 12.6%. Worth mentioning is that unlike most companies, if the economic recovery performs worse than expected, these numbers could actually be higher for the reasons given earlier.

General Motors: Cheap and Risky

General Motors Company (NYSE:GM) became infamous a few years ago due to its bankruptcy and ensuing government bailout. The shares that trade now are of the “new GM” and the company still leaves a bad taste in some investors’ mouths. The truth is that bankruptcy may have been the best thing to happen to General Motors in a long time, and the company is more financially sound than they have been in decades, with a much lower cost structure and greatly reduced debt.