In our Investment Comments last June, we pointed out that “like much of the economic data during this recovery, some recent indicators point to accelerating growth while others cause concern.” As for positives, the job market was taking off as April posted the highest monthly job gains number of the recovery. Consumer spending was grinding back after a brutal winter as well, as retail sales grew an average of 1.3% from February through April. As for negatives, we pointed out that wage growth was still lagging job growth, rising just 1.9% year-over-year in April. Our biggest concern this time last year was corporate earnings growth. In early May of last year, earnings for the S&P 500 companies were growing at just 0.9% in aggregate.
Fast forward a year later and these same economic indicators remain somewhat mixed, but raise more cause for concern than last year. The preliminary jobs number for April showed an increase of 223,000, which was not too hot not too cold, but a nice rebound from an anemically low March number of 85,000. However, wage growth remained subdued at just 2.2% year-over-year. Retail sales also remain subdued, coming in at flat 0% growth for April, making the three-month average for February through April just 0.2%. Finally, corporate earnings growth is lackluster, with first quarter earnings of S&P 500 companies on track to grow just 0.1%. The strong dollar and collapse of the energy sector were the main culprits of this anemic growth. However, compared to forecasted estimates of a 4.7% decline, this is a pretty significant positive surprise, and may point to a better environment going forward.
One of the three companies we profiled in last June’s IAS issue, CarMax (NYSE: KMX), operates in the cyclical used car business, which is sensitive to these macroeconomic factors. However, while vulnerable to economic downturns, CarMax has shown an impressive ability to grow long-term revenue and earnings. On average, the company has grown revenue by more than 10% and EPS by more than 17% annually over the last 10 years. In our comments last June, we argued that there is still plenty of room to grow, with CarMax controlling just a single-digit share of nationwide used car sales, despite being by far the biggest player. We argued the company’s unique one price, no-haggle shopping experience, valuable brand, and highly visible growth and profitability trajectory make it an undisputed leader.
The market clearly agreed with us over the past year, as KMX shares have appreciated more than 60% since we featured the stock last June. The stock quickly gapped up from the $45 level at the time we featured it to the low $50s when CarMax reported a big FQ1 revenue and earnings beat. Revenue rose 13% and EPS expanded 19%. The quarter’s strong growth was spread across the company’s entire business, with strong contributions from the retail and wholesale segments, as well as the finance arm, CarMax Auto Finance (CAF). The stock surged to new all-time highs as the market rewarded the company’s broad sales growth in multiple channels and ability to squeeze out more profit per car than its competitors.
Fiscal Q2 results were the next big catalyst, but results didn’t live up to the market’s lofty expectations and the shares dropped back down to the mid $40s. The market dwelled on the same-store used-car sales metric, which increased only 0.2%. An adverse calendar shift knocked a full percentage point off the metric. Revenue increased 11% and EPS growth after one-time items was just 3%. However, we had expected this to be a tough quarter based on last year’s comparable quarter of extremely strong 18% revenue and 28% EPS growth. In our view, results were primed to accelerate from here, and this looked like a great time to buy the dip.
If you had bought the dip during the first half of last year’s volatile October market, you would have been handsomely rewarded before the month was up, as the stock surged back from roughly $45 to new all-time highs in the mid $50s. The shares were boosted by a number of factors including the overall market rebound, an increase in the company’s share repurchase program, and bullish sentiment from investors towards the car dealership industry. Warren Buffett’s acquisition of auto-dealer Van Tuyl Group earlier in the month was a strong contributor to this bullish and somewhat speculative outlook. At the same time, the market may have been coming around to our view that CarMax was in a great spot to accelerate in the next couple quarters.
Fortunately, CarMax management executed extremely well and proved our acceleration thesis correct when they reported FQ3 results in late December. Revenue growth jumped to 16%, on the back of very strong 7.4% same-store unit sales growth. Leverage and buybacks produced blowout 28% EPS growth for the quarter, which sent the stock surging to the high $60s. Tailwinds of strong market-wide U.S. auto sales, lower gas prices, and better weather gave the shares plenty of momentum going into 2015.
The momentum continued when CarMax reported strong FQ4 numbers that propelled the stock to the low $70s, where it currently trades. Management upped its new store growth guidance, while investors applauded another quarter of 7% same-store unit sales growth. CarMax leveraged 14% revenue growth to deliver 28% EPS growth in the quarter, confirming once again that CarMax is the best of breed versus competitors like AutoNation and Penske Automotive. Best of breed doesn’t come cheap these days, as CarMax shares currently trade at 26.5 times trailing twelve month earnings. However, as we pointed out in our comments last June, due to the lagged effect on profit growth from new stores, “retailers often trade at high valuations while they are in expansion mode, then grow into their multiples as they mature.” Future growth is never a certainty, but what is certain is CarMax delivered some serious value to shareholders over the past year.