CarMax is the largest retailer of used cars in the U.S. The rise of online vehicle sellers, most notably Carvana, have raised concern that CarMax will soon lose its leadership position. However, we believe that the emergence of online vehicle buying presents more opportunity than threat, giving CarMax an opening to further differentiate itself from competition and gain significant profitable market share in the process.
The Original Disruptor in the Used Car Market
Over the last 29 years CarMax has grown from a single store in Richmond, Virginia, to 230 stores across the country becoming the largest retailer of used cars in the process. The company success stems from its consumer-friendly car-buying experience with a wide selection of high-quality used cars, no-haggle pricing, and a generous return policy. This straightforward selling approach contrasts with the adversarial style used by most traditional used car dealers, helping customers feel confident when buying a car from CarMax.
A Massive, Highly Fragmented Market
In 2019, there were more 40 million used cars sold in the U.S., translating into $840 billion of retail sales.1 For all the success CarMax has had, it still has only about 2% overall market share, and 4% share of the late model used car market. CarMax’s primary competitors are the nearly 18,000 franchised new car dealers that also sell used cars: AutoNation, Penske, Asbury Automotive, and Lithia are a few of the larger franchised dealers you may be familiar with. The franchised dealers retail about 14 million used cars a year compared to about 800,000 at CarMax. Beyond the traditional new car dealers there are thousands of independent dealers typically focused on older, higher mileage cars, as well a slew of new entrants attempting to carve out a space for themselves using online/digital vehicle selling.
Scrappy New Entrants Challenging the Market Leader
Carvana, Vroom, Shift, Driveway, and others have entered the used car market. The most well-known of these is Carvana. Carvana, founded just ten years ago, has rapidly grown to become the second largest retailer of used cars in the country. Carvana achieved this success by embracing digital auto sales and home delivery. They have correctly read the changing consumer landscape to find a segment of customers that are not just willing, but often excited to purchase a car online. The wide selection, convenience, and 7-day money back guarantee are enough to win over customers to buying a car sight unseen. Carvana has quickly grown to about half of CarMax’s size, and its current momentum suggests it could potentially overtake CarMax in several years.
CarMax Responds: Omni-Channel Retailing
While CarMax was slow to recognize evolving customer preferences and the threat of online retailers, it has since mounted a furious response. CarMax believes that some consumers want to buy a vehicle online, but the vast majority of consumers still want to visit a showroom to “kick the tires” before making such a large purchase. However, very few want to spend hours at a dealership like still occurs at traditional dealers, so CarMax is enabling customers to conduct as much or as little research, financing and paperwork online as that customer wants. It believes “expedited pickup,” where almost the entire transaction is completed online, then the customer comes to the store for a test drive and final inspection is the pathway that will enable it to wow customers. CarMax refers to these capabilities as its Omnichannel initiative, and is well along the pathway to completing the disperate technology and operational pieces required to deliver this solution. Importantly, neither the traditional dealers nor the online retailers have the nationwide store footprint, logistics network, no haggle pricing, marketing and IT budget, and wide vehicle selection to match CarMax in this capability.
Over the coming quarters we expect to see the completion of important pieces of the omnichannel capability and more aggressive marketing and advertising support to build awareness.
Early Signs of Online Success
Over the years, CarMax has built a reputation as a place where you could sell your used car even it you did not buy a car from CarMax. Until recently, CarMax procured about one-third of its vehicles for retail through this “appraisal lane” directly from the public. This is a very attractive source of vehicles for CarMax because (1) it costs less than buying supply at large professional auctions, and (2) wholesaling off unwanted appraisal vehicles to other local dealers provides a nice additional source of profit.
One of CarMax’s key milestones in its omnichannel efforts was enabling online appraisals, allowing customers to receive an accurate purchase offer for their vehicle from CarMax without ever setting foot in a store. This was launched in the first half of 2021, and it has been a big success. Volume is up significantly; CarMax now procures more than 70% of its inventory through the appraisal lane, and wholesale profits are booming. This is a key advancement for the company, and we think it bodes well for other digital initiatives due to rollout in the future.
Ultimately we think there is room for a few big winners in online and omnichannel used vehicle retailing - of which CarMax is likely to be one.
What’s Driving the Current Used Car Market: Reduced Supply and Increased Demand
Over the past two years, there have been multiple factors affecting the supply and demand dynamics in the used car market.
Primarily, fewer new cars are being manufactured as the world faces a semiconductor chip shortage. There have also been also geopolitical factors at play. American firms were cut off from chips made by China’s Semiconductor Manufacturing International Corporation after the federal government blacklisted the firm.2 The pandemic that caused a significant decrease in vehicle sales in the spring of 2020 also caused orders to be cut that included the electronic chips. The demand for autos rebounded by the third quarter of 2020, but the damage had already been done. By the end of 2021, analysts predict a production shortfall of almost 8 million vehicles, and this shortage could stretch into 2023.3
A lack of new cars has caused spikes in demand and price for used cars. The used and new car markets are interconnected: When one experiences higher prices, the other will be affected. Therefore, although the volume of used car sales has remained consistent, there are fewer new cars being manufactured, inflating prices.4 From 2019 to 2021, the average price for a used vehicle has increased 42% to $28,205.5 These used car prices are not expected to substantially decline until manufacturers can start producing cars at rates closer to pre-pandemic levels.
Our Independent Research and Key Insights
CarMax continues to meet our key investment criteria:
High Quality Business
• Customer friendly value proposition
• Hard to replicate national footprint, logistics network, and brand
• Burgeoning online capabilities unique in the market
Large Growth Opportunity
• CarMax is the industry leader in a highly fragmented market, yet it has just 4% market share providing lots of opportunity for expansion
• Omnichannel initiatives should enable the company to grow more quickly and generate more sales per store in a capital efficient manner
• The business produces significant free cash flow enabling 3-4% repurchase of its shares each year
• Long-term oriented management with a customer friendly and continuous learning/testing culture
• Intelligent capital allocation with regular and opportunistic share repurchases and acquisitions
• The stock trades at less than 15x consensus estimates for calendar 2022
Overall, we believe CarMax is a well-run, high-quality business with a large growth opportunity. CarMax has stepped up its digital tools and progressed its omni-channel approach to selling used vehicles. It brings value by offering a simple and fast way for people to trade in their vehicles for a fair price. We believe CarMax is well-positioned for long-term growth over the next decade.