At first glance, the narrative for used-car dealership CarMax (NYSE:KMX) appears incredibly suspect. That’s because rival secondhand vehicle specialist Carvana (NYSE:CVNA) features a similar business. Moreover, the latter enterprise faces the very real possibility of bankruptcy. Nevertheless, it’s important to realize that the two companies – while similar – have different business mechanisms. Plus, the demand for personal transportation won’t fade. Therefore, as speculation, I am bullish on KMX stock.
To be fair, the wider framework for the used-car sector isn’t pleasant no matter where you look. As TipRanks reporter Kailas Salunkhe mentioned, the consumer price index “pointed toward a cooling price environment for used vehicles.” While segments such as food and medical products/services increased, the car and truck index declined in the September print.
Just by the recent price action for KMX stock and rival Carvana, circumstances have not improved for the better.
Further, Carvana stares at an existential crisis. As TipRanks reporter Shrilekha Pethe stated, “Wedbush analyst Seth Basham downgraded the stock to a Sell from a Hold and slashed the company’s price target to just $1 from $15 earlier.”
Further, Pethe cited a Bloomberg report which mentioned that “a group of CVNA’s largest creditors, including Apollo Global Management and Pacific Investment Management holding around $4 billion of the company’s unsecured debt, have signed a pact to act together in negotiations with the company. This pact will last for a minimum of three months.”
Unfortunately, Basham sees “a high probability of default,” thus explaining the poor view on CVNA. However, KMX stock did not receive an exemption from the pain. Since the start of this year, CarMax lost more than 48% of its equity value.
Still, investors should note that CarMax and Carvana are not the same.
KMX Stock Still Benefits from Core Demand Inelasticity
To reiterate, no one suggests that KMX stock represents a sterling investment. Certainly, if a market participant operates under a conservative profile, CarMax would probably not be appropriate. Nevertheless, it’s also not fair to suggest that the used-car dealership owns no redeeming attributes. Quite the contrary, the business offers some level of core demand inelasticity.
Under the classic definition of inelastic demand, the underlying product or service will enjoy constant demand irrespective of pricing fluctuations. Obviously, that’s not the case with personal vehicles, which often represent the average household’s second-most expensive purchase. With interest rates rising – which implies higher borrowing costs – consumers scaled back their purchases.
Indeed, the average age of cars on U.S. roadways is 12.2 years. This implies that even before the COVID-19 pandemic, consumers stretched their dollars through repairs and other maintenance items. Whatever drivers could do to hold onto their vehicles before incurring another car payment, they did.
This dynamic speaks to the increased reliability of personal vehicles overall. Still, no matter the improvements, cars ultimately represent a wear-and-tear platform. Even the most reliable vehicles will eventually incur serious maintenance activities, such as transmission replacements. While cars may be more reliable than decades ago, they also feature more complex electronics. When those fry, the repair bills can rack up.
Cynically, this backdrop bolsters the case for KMX stock. At some point, cars become money pits: the cost to maintain, repair, and insure them becomes onerous. In addition, significantly aged vehicles lack warranty coverage.
However, CarMax solves both issues, providing new-ish vehicles while also offering extended warranties, providing some peace of mind.
Is KMX a Good Stock to Buy?
Turning to Wall Street, KMX stock has a Moderate Buy consensus rating based on four Buys, seven Holds, and zero Sell ratings. The average KMX price target is $79.00, implying 18.58% upside potential.
CarMax Offers the Sensible Alternative
Naturally, the criticism regarding bullishness toward KMX stock centers on lack of distinguishment. For instance, Carvana also offers new-ish vehicles and extended warranties. What separates the two? Primarily, CarMax occupies the lower rung of the trade-down effect. Not surprisingly, Carvana enjoyed extreme relevance during the worst of the COVID-19 pandemic. Back then, companies that offered contactless services commanded a premium.
However, pandemic fears have faded, and Carvana, which specializes in delivering vehicles to customers’ doorsteps, can no longer justify its premium.
Indeed, market observers only need to look at the quantitative financial data to see the point. Again, both CVNA and KMX stocks stink; let’s be honest about that. However, one clearly stinks less than the other. Mainly, on a trailing-12-month basis, CarMax’s operating margin and net margin sit at a lowly 3.3% and 2.3%, respectively. However, the business remains profitable.
On the flip side, you have Carvana. While CVNA features a slightly superior gross margin, its operating and net margins ping at approximately 8% and 6% below parity, respectively. In other words, without the fear of COVID-19, consumers choose to do business with CarMax.
Under a consumer backdrop imposing steep pressures, people will organically seek out the lowest-cost alternative, that is unless some compelling reason to pay a premium exists. Two years ago, the COVID-19 crisis provided this reason. However, today, it’s gone, meaning that KMX stock might soak up the demand that exited from Carvana.
