CarMax, Inc's (NYSE:KMX) Fair Value is Close Enough to Current Prices
This article first appeared on Simply Wall St News.
Supply chain issues bottlenecks frustrated a lot of vehicle buyers in recent times. With production halts and increased waiting on new car delivery, it is not surprising to see used vehicle retailers like CarMax, Inc. (NYSE: KMX)do well, as their stock significantly outperformed in 2021.
Yet, 2022 has been the opposite, as the stock erased all the gains in the last 16 months, reaching attractive price-to-earnings (P/E) levels.
View our latest analysis for CarMax
Q4 FY 2022 Earnings Results
GAAP EPS: US$0.98 (miss by US$0.25)
Revenue: US$7.69 (beat by US$110m)
Revenue growth: +49% Y/Y
Other highlights
10 new stores announced for FY 2023
FY 2023 CAPEX of US$500m
Long-term sales targets: 2-2.4m vehicles by FY2026
While revenues rose significantly year-over-year, the earnings were disappointing for the analysts. CEO Bill Nash reflected on that miss, quoting consumer confidence, vehicle affordability, Omicron COVID impact, and the government's stimulus programs stoppage.
Following the earnings results, the stock declined by almost 10%, thus prompting us to take a look at a fair valuation through the Discounted Cash Flow (DCF) model. There are many ways to estimate a company's value, and a DCF is just one method. If you still have some questions about this type of valuation, look at the Simply Wall St analysis model.
The model
We're using the 2-stage growth model, which means we take into account two stages of the company's growth. In the initial period, the company may have a higher growth rate, and the second stage is usually assumed to have a stable growth rate. In the first stage, we need to estimate the cash flows to the business over the next ten years. Where possible, we use analyst estimates, but when these aren't available, we extrapolate the previous free cash flow (FCF) from the last estimate or reported value.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) forecast
2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | |
Levered FCF ($, Millions) | US$696.3m | US$1.09b | US$1.29b | US$1.36b | US$1.42b | US$1.47b | US$1.52b | US$1.56b | US$1.60b | US$1.64b |
Growth Rate Estimate Source | Analyst x1 | Analyst x2 | Analyst x2 | Est @ 5.62% | Est @ 4.51% | Est @ 3.73% | Est @ 3.19% | Est @ 2.81% | Est @ 2.54% | Est @ 2.36% |
Present Value ($, Millions) Discounted @ 9.5% | US$636 | US$906 | US$979 | US$944 | US$901 | US$853 | US$804 | US$754 | US$706 | US$660 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$8.1b
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten-year period. In this case, we have used the 5-year average of the 10-year government bond yield (1.9%) to estimate future growth. In the same way, as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 9.5%.
Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = US$1.6b× (1 + 1.9%) ÷ (9.5%– 1.9%) = US$22b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$22b÷ ( 1 + 9.5%)10= US$8.8b
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$17b. We divide the equity value by the number of shares outstanding in the final step.
Compared to the current share price of US$93.3, the company appears to be about fair value at an 11% discount to where the stock price trades currently.
Important assumptions
The calculation above is very dependent on two assumptions. The first is the discount rate, and the other is the cash flow. The DCF also does not consider the possible cyclicality of an industry or a company's future capital requirements, so it does not give a complete picture of a company's potential performance. Given that we are looking at CarMax as potential shareholders, the cost of equity is used as the discount rate rather than the cost of capital (or a weighted average cost of capital, WACC), which accounts for debt. We've used 9.5% in this calculation based on a levered beta of 1.797.
Conclusion
Following CarMax's decline, we've looked into the valuation through a discounted cash flow model only to determine that our estimations place the stock at the levels from days ago. Even at a P/E ratio of 14, there is a limiting upside perspective. We also aren't impressed that the company doesn't pay a dividend.
Overall, we aren't impressed with the stock at this moment, but for those who'd like to dig deeper, we've put together three fundamental aspects you should explore:
Risks: We believe you should assess the 3 warning signs for CarMax we've flagged before further research.
Future Earnings: How does KMX's growth rate compare to its peers and the broader market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
Other High-Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality stocks to get an idea of what else is out there you may be missing!
PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NYSE every day. If you want to find the calculation for other stocks, just search here.
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Simply Wall St analyst Stjepan Kalinic and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
