The breakdown of CarMax is a bad sign for the entire automotive industry

Investors mostly looked beyond the challenges of the auto industry. That could change, with big implications for the shares of the biggest car dealers.

frames to CarMax (KMX) said last month that demand for used vehicles was slowing as consumers grapple with affordability issues. The shares quickly fell 25%. Then Moody’s downgraded the whole industry.

Aggressive investors should consider further bearish bets on CarMax. Let me explain.

The automotive industry is changing. Along with the transition to electrification and the move away from internal combustion engines, most of the world’s largest automakers are still crippled by supply chain shortages. Investors have been willing to look beyond these challenges. The gamble was pent-up demand and relatively greedy consumers would lead to big sales gains in the future.

Analysts at JD Power and LMC Automotive noted that retail sales in September are expected to reach 958,948 units, up 5.4% from a year ago, according to a Press release at business thread. The researchers found that sales promotions, a normal September event, were non-existent. And despite rising short-term interest rates, transaction prices continued to rise, suggesting pricing power.

Cox Automotive – the publisher of automotive industry staples like Autotrader, Kelly Blue Book and Manheim – wrote in September that overall vehicle sales in the third quarter are expected to reach 3.4 million units. Despite higher rates reducing demand, researchers still expect big gains at General Motors (GM), Ford (F)and Tesla (TSLA).

News from CarMax is a game changer.

The Richmond, Virginia-based company is the newest used-vehicle retailer in the United States, with 220 superstores and combined unit sales of 1.6 million in fiscal 2022.

CEO Bill Nash said last week that used car prices fell slightly in August month-on-month, but remained 7.8% higher than a year ago. Nash notes that the bigger issue is that unit sales are falling, driving profits down 50% from a year ago. He says buyers are now prioritizing spending as rates rise.

Following the CarMax results, Moody’s downgraded the entire global auto industry, according to a report on Auto.com. The company changed its outlook from negative to stable, noting higher production costs, lower consumer demand and, most importantly, higher interest rates that are making loans and lease rates less attractive for the buyers.

The latter will be a big deal for CarMax and its CarMax Auto Finance unit. CAF and its lending partners are used by around 80% of CarMax buyers. This astonishing figure is concerning because CAF does not have a minimum credit score or credit history requirement. The company says it makes vehicles accessible to customers across the credit spectrum, even buyers with FICO credit scores below 630. Those buyers may have trouble getting loans elsewhere.

There is a cost for borrowers with poor credit scores. Their loans will come with much higher annual interest rates. These borrowers are also the most vulnerable to a weakening macro economy, such as soaring inflation and rising unemployment. Unfortunately for loan originators like CAF, delinquency rates for auto loans are rising, especially among subprime borrowers.

Cox Researchers found in July, 60-day delinquency rates were up 3.9% from June and 32.1% from a year ago. In addition, in July, 1.56 of auto loans were seriously delinquent, the highest rate in five months.

Auto industry investors have been concerned about the transition to electric vehicles and the idea that car sales will rebound strongly once automakers address supply chain issues. Few investors are focused on destroying demand due to rising interest rates or the industry’s exposure to rising bad debts for vehicles. The news from CarMax is the first hint that both factors will be a concern in the future.

CarMax stock fell 25% on Thursday to its lowest level since April 2020. The trading outlook was much better then. The Federal Reserve cut interest rates to zero and pledged to keep them there for three years. The opposite is true now. The Fed wants to raise rates to 4.25% in early 2023, even as loan delinquencies rise.

At Friday’s closing price of $66.02, shares of CarMax are trading at 13.4 times forward earnings and 0.3 times sales. While these metrics may seem small, it’s important to note that the forward numbers don’t yet reflect the drop in sales. Nor do they explain the deterioration in profitability in 2023 as delinquency rates increase.

A share price of $48.20 is more appropriate given the short-term changes. A drop from this level would yield a profit of 27% for bearish bets.

Safety is for suckers. Our suite of research services has helped thousands of independent investors grow their wealth by harnessing the power of peril. Learn how to transform fear and confusion into clarity, confidence and fortune. Try our flagship service for just $1. Tactical Options The newsletter recommends entry, target, and stop levels for in-the-money, near-month, and highly liquid options of large companies. Trades typically take one to five days to unfold and target gains of 40% to 80%. The 2022 results as of August 1 are approximately 180%. Click here for a 2 week trial at $1.

Comments are closed.