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This Car Dealer May Be Going Places


Given the death and destruction trailing Hurricane Charley, anyone might miss noticing some of its minor victims. One would be CarMax (KMX), the chain of used-car superstores with many outlets in Florida and throughout the soggy Southeast. As skies there cleared, a low-pressure system hovered over CarMax shares.

The damper Charley put on car shopping is not the first trouble CarMax has suffered. Since January the stock is off by nearly half, to $19, as the Glen Allen (Va.) company keeps warning that business is softer than expected. On Aug. 17, Wall Street analysts got a fresh reason to cut ratings on CarMax when it said same-store sales of used cars in its fiscal second quarter, ending Aug. 31, would fall. While that was a probability before the storms struck, Charley made it a foregone conclusion. Just the same, I bet investors now have a chance to get a good growth stock at a reasonable price.

THE OTHER DAY, I STOPPED at CarMax in Orlando, one of its 55 locations. Within 50 minutes, I had examined several convertibles, including Ford Mustangs, a Mitsubishi Eclipse Spyder GT, and a BMW Z3. I also test-drove a sweet 2000 Mazda MX-5 Miata with just 35,000 miles on it. While I tooled around in the Miata, CarMax appraised my current car and made a solid offer on it. CarMax would buy my car whether I bought a new one that day or, as it happened, did not. That's the key to CarMax: It sets no-haggle prices on cars it sells, it makes a no-haggle offer on the car you bring in, and you're free to take any part or all of the deal and finance it as you like without the customary buyer-dealer warfare. Sales reps get paid the same whether you buy a Kia or a Corvette. As one told me: "There are no mind games."

Appealing as that is to car buyers, it should be no surprise that since 1993, when CarMax opened its first location in Richmond, Va., it has spread to 25 more markets. The financial results are compelling. Since fiscal 2000, sales have more than doubled, to $4.6 billion, in fiscal 2004, ended Feb. 29. Net earnings for the fiscal year grew 23%, to $116.5 million. This year, as CarMax aims to add 10 stores, revenue may grow an additional 13%, to $5.2 billion or so, even if wary consumers slow car purchases. Despite that prospect, CarMax figures to remain solidly profitable. With a healthy balance sheet and a focus on the less competitive market in used cars, CarMax enjoys wider margins than other publicly held auto dealers, notably leader AutoNation (AN). Yet investors value the two stocks at equivalent multiples.

Still unknown in vast parts of the U.S., CarMax plans to expand its base of stores by 15% to 20% a year, which suggests 11 or so more next year and eventually over 250. The company figures that in areas it has served the longest, its market share for cars that are one to six years old runs 8% to 10%. At similar rates nationally, CarMax would see annual sales of more than $21 billion. Every company with such a growth plan runs risks, naturally. Morningstar equities strategist Mark Sellers, who bought the stock for a model portfolio he runs, says one risk CarMax faces is a surge in interest rates. That could create a loss on the loans CarMax makes and holds briefly before selling into the secondary market.

Yet with the stock near $19, the risks in CarMax seem tolerable. Primecap Management, whose Vanguard Primecap Fund (UPMCX) has beaten the Standard & Poor's 500-stock index by an annual average of 2.5 percentage points since 1984, has built a 7% stake in the stock this year. CarMax insiders also have been recent buyers. Like riding in a fast car on a curvy road, most growth stocks make me queasy. Not this one.

By Robert Barker


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