Primecap Management Increases Stake in CarMax

Author's Avatar
May 27, 2015

Primecap Management Company (Trades, Portfolio) was founded in September 1983 in Pasadena, California. It manages Vanguard Primecap Fund, Vanguard Capital Opportunity Fund, and Vanguard Primecap Core Fund.. Primecap was founded by Chairman and Chief Investment Officer Howard B. Schow, Vice Chairman Mitchell J. Milias, and President Theo A. Kololotrones.

Primecap's team evaluates securities based on their outlook over a three to five-year time horizon, with the intention of holding them considerably longer if their fundamentals warrant it. They believe successful investment decisions rests in correctly appraising the relationship between the fundamental value of a company and the market price of its stock. A company may be valuable because of its free cash flow, its assets, or both; however, a company will be a superior investment only if it is purchased at the right price. Primecap only invests in their highest conviction ideas.

Last quarter, Primecap increased its stake in CarMax (KMX, Financial) by buying 226,935 shares. As of March 31, 2015, the firm held 13,463,486 shares of the company. The following chart shows Primecap's holding history in the company.

03May20171110181493827818.jpg

CarMax is the nation’s largest retailer of used cars, based on the 526,929 used vehicles it retailed during the fiscal year ended Feb. 28. As of the end of fiscal 2014, the company operated 131 used car superstores in 64 metropolitan markets. CarMax is the first used vehicle retailer to offer a large selection of high-quality used vehicles at low, “no-haggle” prices using a customer-friendly sales process in an attractive, modern sales facility. It allows customers to shop for vehicles the same way they shop for items at other “big-box” retailers. In addition the company also provides financing alternatives to its customers through CAF, its own finance operation and third-party financing providers.

CarMax's shares have risen 60% over the last one year due to accelerating sales and earnings growth. Ron Baron (Trades, Portfolio) of Baron Funds recently highlighted his bullish thesis on the company stating:

“Demand for the company’s high quality, late model vehicle inventory has remained strong and coincides with resurgent new car sales and an attractive financing environment. In addition, shares have been buoyed recently by the announcement of a large share repurchase program that we believe will be significantly accretive to earnings over the next several years.”

I believe CarMax’s stock is likely to continue its outperformance. The company's EPS forecast for the current fiscal year is $3.04 and next year is $3.42. According to the consensus estimates, its top line is expected to grow 10.50% current year and 12.50% next year. It is trading at a forward P/E of 21.13. Out of 16 analysts covering the company, eight are positive and have buy recommendations, seven have hold ratings and one has a sell rating.

Last quarter, CarMax posted 14.2% revenue growth, 44.3% net earnings growth, and 52.3% earnings per share growth. The company reported a 7.0% increase in comparable-store sales. During this period, the company opened one store in Cleveland and repurchased 3.4 million shares of common stock for $210.6 million.

In addition to store and store traffic growth, the company's web traffic also continued to expand. For the last quarter, average monthly web visits grew over 9% year-over-year to nearly 14.5 million. Visits to CarMax's mobile site continued to grow and represented approximately 32% of total visits, while visits utilizing its mobile apps represented another 16% of the total.

The company has a customer friendly model and is still in early phase of national roll out. CarMax is trading at a forward PE of 21.78. The company's EPS has grown from $1.79 in FY2012 to $2.82 in FY2015. Analysts are expecting the company's EPS to grow by 8.36% in FY2016 and 10.16% in FY2017. Given the company's long-term growth potential, I believe the company is a good buy.