CarMax's Upside Is Limited, Says Sterne Agee CRT

Sterne Agee CRT’s Ali Faghri downgraded the rating on CarMax, Inc KMX from Buy to Neutral.

Near Term Pressures

“While we remain positive on the long-term growth potential, near-term competitive pressures are more pronounced than we initially expected,” Faghri explained.

Faghri does not expect the company’s comps to recover in the short term, given the aggressive pricing by its public dealer peers, who are also expected to accept margin declines in order to increase their service backlog.

In addition, the limited supply of late-model SUVs is expected to continue to be a headwind, while Carmax’s 15 percent third party subprime exposure is expected to add more volatility, “as some lenders tighten underwriting standards.”

Aggressive Pricing

“Simply put, while our earnings outlook is only modestly reduced, we now believe the market is unlikely to assign a higher multiple to KMX shares in this backdrop, limiting upside and warranting a Neutral rating,” according to the Sterne Agee CRT report.

Faghri explained that with incentives on new vehicles increasing modestly in 2H15 and early 2016, late-model used vehicles sales have been impacted, a segment that accounts for 80 percent of the company’s sales.

“For both new and used vehicles, the key competitive advantage of franchised dealers over KMX is a parts & service offering that can be used offset profit declines and drive customer acquisition,” the analyst said, while adding that “pricing trends should stabilize over coming quarters as inventory levels adjust.”