Why CarMax Plunged in September

Shares of used car giant CarMax (NYSE: KMX) plunged 26.9% in September, according to data from S&P Global Market Intelligence, drastically underperforming an otherwise positive month for the markets.

Not only is CarMax not a part of the AI tech stock cohort that saw massive interest in September, but the company also reported earnings during the month, which fell well short of expectations.

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CarMax reports declines and announces cost cuts

In its second quarter, CarMax reported revenue declines of 6% to $6.59 billion, and an earnings per share decline of 24.7% to $0.64. Both figures missed analysts' expectations.

Management acknowledged the challenges of the current quarter, but pointed to new initiatives it anticipates will turn things around. The first is a cost-cutting initiative, by which management is seeking $150 million in selling, general, and administrative cost cuts over the next 18 months.

The second is on the marketing front, where CarMax unveiled its new "Wanna Drive?" campaign in August. The "Wanna Drive?" campaign highlights CarMax's new omnichannel capabilities, a competitive reaction to online-first competitors such as Carvana (NYSE: CVNA) and others.

But while that all may sound promising, CarMax is fighting against an unfavorable macroeconomic environment. Late in September, the Conference Board reported a worse-than-expected decline in consumer confidence, with a reading of 94.2, down from 97.8 in the prior month and well below the 96.0 reading expected by economists.

Automobile purchases are big-ticket items, so consumers may hold off purchases if their confidence in the economy and their future prospects darkens. While the Federal Reserve did commence cutting interest rates in September for the first time in nine months, it likely did so in reaction to a weakening job market and economic outlook, even as inflation remains above its target.

Can CarMax turn it around?

After the September decline, CarMax looks somewhat cheap on the surface, now trading at 14 times this year's earnings estimates and just 11.8 times next year's earnings expectations.

It therefore appears CarMax may be a value stock that could be appealing to investors shying away from the high valuations of the AI and technology sector.

Of note, CarMax does have over $16.4 billion in debt, but that debt is backed up by roughly the equivalent amount of CarMax auto finance loans, which CarMax holds on its balance sheet, and from which it generates a positive interest rate spread.

So while CarMax shouldn't be considered "heavily indebted," its business is very economically sensitive, in that used cars are big-ticket items, while the auto loan financing business essentially functions like a bank. Overall, CarMax is also a low-margin business, with a net profit margin of just 1.4% last quarter.

So CarMax looks like a cheap stock at the moment, but investors need to bank on a cyclical recovery or stabilization in consumer spending for the stock to deliver on that promise.

Billy Duberstein and/or his clients have no position in any of the stocks mentioned. The Motley Fool has positions in and recommends CarMax. The Motley Fool has a disclosure policy.