CarMax Beats as Financing Profits Overshadow Used Car Sales

SPEAKER_1 (0:00)

Joining me for this conversation, Tony Zipparro, CEO at EquitySec. Great to see you, Tony. I'm so glad you're here. Right now, CarMax is trading up almost 5%.

You noted that CarMax is not just used cars. In fact, it's actually also sort of a bank. Let's talk a little bit about what you thought of these CarMax earnings reports.

Tony Zipparro (0:21)

Yeah, great to be here, and thank you for having me.

As you kind of said, everyone thinks from a retail perspective, CarMax just sells used cars.

But the lesser known, to kind of non-analysts, is the whole financing side of it. So while CarMax sells used cars, a ever growing and ever profitable, more profitable side of their business is the actual financing side, CarMax Auto Finance, or CAF. And the interesting thing about the earnings is, so they had a big beat, again, still up about 4 or 5%, came down a little from where it was at earlier today. But that was largely because their headline numbers, they beat 14%, the car sales higher than they were expecting. They had a 43 cent beat on top of what they were expecting for 73 cents. Digging into those numbers, so good numbers, right? You sell more cars, you sell at a higher price, all good things. And so, it definitely has a little bit of tailwinds. That is a good sign you want to look for. I think one of the interesting things is as you dig in, 5% of the revenue from CAF, the financing division, produced actually about 60% of the profits. And so, one of the big things from a fundamental shift that you didn't see a year or two ago, is a lot of the profit is being driven by the financing side. And not only that, a lion share is coming from the subprime or riskier lending side, which is providing a boost to their business.

SPEAKER_1 (1:58)

Well, you know, there's so much to unravel here. I mean, the sales numbers beat the estimates. The company also announced that they plan to resume some share repurchases. They haven't been repurchasing stock, so you were talking about the new leadership and that you do like that. They also noted that the lower end of the customer, even the lowest income customers are holding up despite some of the affordability issues and the squeeze that we've been seeing. You had some concerns on auto delinquencies in your notes, but they're saying they seem to be doing okay with it at this moment. What do you think? Because if they're making riskier and riskier loans, what could that mean?

Tony Zipparro (2:40)

Yeah, and I think if you're zooming out a little bit and you've kind of got this idea of a K-shape economy where they're saying, hey, the lower-end buyer who isn't making as much money is still, we're still approving, they're still buying, right? That's of course a good sign because it's providing a lot of profits to their bottom line. I think the interesting shift is whereas a year ago, that was about 10% of their business. So Prime, right, lenders, or lending to Prime borrowers is the largest book of their business for sure. But whereas the subprime was about 10% a year ago, it's now up to 22% of which a couple of quarters ago, they said, we're going to max it out at 15%. So they've clearly gone through that. And the more interesting thing is they're actually starting to offload this paper that they're writing, which is something they've done in the past, but not in the last couple of years. And so what I mean by that is similar, right, to mortgages leading up to 2008

CAF is basically writing the loans and then selling them to yield hungry investors, whoever those might be, which are 100% more interest rate economy sensitive. So while they are definitely able to be more profitable off those currently, I think the concern is that at any point that that buyer faults or stumbles, a lot of that profitability of the loans they're selling away falls on somebody. And the good thing is they're actually making a smart move by selling it away because then they're not left holding the bag. But I think the question is what happens if there's a little stumble while they're writing those loans or they left holding all those loans or who is the counterparty that has the risk that is being sold them. So all good things. It's not like tomorrow necessarily. The bottom is going to fall out. But I think it is an interesting thing to watch as potentially higher rates, a weakening economy, and those buyers get squeezed even more, especially because we just saw a quarter percent up. And despite the last year of the Fed cutting, the actual rate that CarMax had financed at was actually up around 11.8%.