Equity Research on Automobile Industry by ugn12413

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									                  Louis Wilson Fund - Equity Research
                                November 23, 2009                    Analyst: Kyle Jones
CarMax Inc.                                                                                    (KMX - NYSE)
                  PRICE: $20.10              52 Week Range: $5.47-23.07             S&P 500: 1,091.38

LWF Company Rationale:
         I am rating CarMax, Inc a hold. I neither recommend buying not selling KMX. CarMax’s intrinsic value is
currently $24 per share, with a four year target price of $37. After considering a 30% margin of safety, my targeted price is
$17 per share. CarMax is currently trading at around $20 per share, which is above the targeted purchase price. The stock
recently hit a 52 week high at $23.07, which is close to the stock’s intrinsic value. While the company has a history of
earnings growth and strong performance, it is hard to justify purchasing KMX at current prices. Also, I recommend selling
the stock in 2010 if it crosses the $29 threshold, which is the intrinsic value and an additional 10% sell premium.

            Company Characteristics that meet the LWF Strategy:

            Business Summary: CarMax is the nation’s largest retailer of used cars and trucks. Also, the company
             provides customers financing options through CarMax Auto Finance. CarMax operates over 100 used car
             retail centers throughout the United States and five new car dealerships. The company’s differentiation
             strategy is structured around providing four key customer oriented benefits: “no-haggle” prices, a large
             selection, high quality vehicles, and a customer-friendly sales process. All CarMax used car superstores
             provide vehicle repair service, including repairs of vehicles covered by its service plans. The cars sold by
             CarMax are typically less than six years old and the company provides no haggle pricing (Yahoo Finance).

             The stock is up approximately 60% since April, 1 2009, going from $12.46 to $20. The company trades at a
             forecasted P/E ratio of 21 and approximately a 0.95 EPS. Market Capitalization is over $3.5 billion and the
             company does not pay a dividend.

            Growth Strategy: CarMax’s rapid expansion placed their used car supercenter concept in many mid to large
             sized markets. These markets were the easiest to penetrate from a real estate and advertising perspective. The
             company, which was increasing stores 10-15% per year before the recession, has halted expansion plans
             through the rest of FY2009 (ValueLine). In FY2010, CarMax will more than likely resume their historical
             growth rate. Once the economy turns around, the company should be able to grow internally and by
             additional new stores (Morningstar).
            The company released its 2Q 2010 earnings report on September, 22 2009. Revenues increased 13% during
             the quarter, as he Cash for Clunkers program significantly increased traffic into the stores. Same store sales
             also grew an impressive 8% during the quarter, which, in turn, impacted the service and financing operations.
             Cost cutting increased gross margins, in conjunction with the increases due to the Cash for Clunkers program
             helped the company post a quarterly profit record of $0.46 per share. The company will hold their 3 rd quarter
             2010 earnings report on December 18, 2009.

            Management: As mentioned above, the company established an effective business model that is the best of
             its kind (Morningstar).
            Only ½ of 1% of shares of KMX are owned by insiders (MorningStar).
            Forecast EPS for 2009 $0.95 and forecast EPS for 2013 $1.45 (ValueLine).

Industry, Competitive, and Regulatory Factors:
         Industry and Market
          The outlook for the retail market is neutral. However, the price of used cars have increased, which could
             increase profit margins for the company (Standard & Poor’s).
          Cash for Clunkers has spurred the recent increase in automobile purchases. This stimulus does not appear to
             have caused a long term turnaround.
          The weak housing and credit markets as well as low consumer confidence reduce demand for big ticket items
             such as automobiles (Standard and Poor’s).
           Closure of hundreds of Chrysler and General Motors dealerships should help sales growth for other
            dealerships (Standard and Poor’s).
           No competitors have successfully duplicated CarMax's business model, providing the company with a
            considerable head start on would-be imitators (MorningStar).
           The company’s P/E ratio is higher than it peers, which could indicate a more expensive stock. Price to book is
            inline with competitors, while its Price to Earnings Growth, PEG ratio, is much lower than its peers,
            indicating a value (TheStreet.com).
        

Risk:

           The weak housing market, credit market and low consumer confidence reduce demand for big ticket items
            such as automobiles (Standard and Poor’s).
           Repeat business every five years is not a sure thing (MorningStar).
           Relative ease of entry for another used car competitor to establish itself and also nothing prevents another
            company from using the CarMax Business Model (MorningStar).
           Discount programs from new dealers could hurt demand for used dealers (MorningStar).
           A prolonged recession combined with lack of credit may impact sales (Standard and Poor’s).




Valuation:
           I recommend a rating of hold on CarMax based on the company is already priced higher than the
            recommended buy price. The recent run-up in share price has reduced potential upside (The Street and
            ValueLine). However, forecasts for 2012-2014 show promise (ValueLine).
           KMX is currently selling at $20 a share, which is close to its 52 week high of $23.
           According to P/E valuation, KMX has an intrinsic value of $24, and a buy price of $17, thus the company is
            currently trading above its targeted buy price.
           P/E ratio is 21x 2009 earnings estimates.
           I expect CarMax to sell at a P/E of 23x and expect a stock price of $33 in 2013. ValueLine uses future P/E
            multiple of 25, which I feel is an overly optimistic view. A 23 multiple going forward is more appropriate for
            a post Cash for Clunkers industry (Credit Suisse).
           Using current price of $20 per share and a future P/E of 23 and an EPS of 1.45, the stock will trade at the $36
            range. This results in a 13% rate of return.
           Intrinsic Value:                                             High        IV           Low
            P/E @ 8.67%                      Range 7x to 28x             $29        $24          $7
Stock Performance Graph (last 5 years):
  P/E Multiplier Model
BBY                KS=         8.37%
  Current
   Price:                                    0         1       2        3           4
 $20.24                               2009      2010E      2011E    2012E       2013E
            Expected EPS             $0.95       $1.00      $1.20    $1.30       $1.45
            Expected Dividend        $0.00       $0.00      $0.00    $0.00       $0.00
            PV Expected Dividend                 $0.00      $0.00    $0.00       $0.00
            FV Yr. 4 Expected
            Dividend                             $0.00     $0.00    $0.00       $0.00
            TERMINAL VALUE OF STOCK + FV Dividends
                                                                             FV=TV+Di
                   P/E Range           PRESENT VALUE                                v
            High               28           $29      $32     $35      $37         $41
            Low                 7            $7       $8      $9       $9         $10
            VL est.            25           $26      $28     $31      $33         $36
            My
            estimate           23           $24      $26     $28      $31         $33

            MARGIN OF SAFETY PRICES
                     Margin of Safety= 30%
                    P/E Range          PRESENT                               FUTURE
            High                    28      $21      $22     $24      $26        $28
            Low                      7       $5       $6      $6       $7         $7
            VL est.                 25      $18      $20     $22      $23        $25
            My
            estimate                23      $17      $18     $20      $22         $23

            SUGGESTED SELL PRICES
                                 Sell
                           Premium= 10%
                    P/E Range         PRESENT                                FUTURE
            High                28.0       $32       $35     $38      $41        $45
            VL est.             25.0       $29       $31     $34      $37        $40
            My
            estimate            23.0       $27       $29     $31      $34         $37

            Summary                       2009
            Current Price                  $20
            Intrinsic Value VL             $24
            Recommend Buy My
            Est.                           $17
            Recommend Sell VL              $29       $31     $34      $37         $40

								
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