The U.S. automobile  market is expected to bounce back this year, following a record decline in sales last year. Cox Automotive estimates new car sales will  rise in the range of 7.6% to 10.3% in 2021, following a 14.8% decline last year. Used car markets have been the key driver of the automotive market’s fast-paced recovery. Rising demand for personal transportation amid the pandemic benefited primarily used car sellers.

The inventory of used cars as of last month was  12% lower than at  the same period last year. Furthermore, the automotive industry’s “spring bounce”, which began relatively early, in February, led to a 17.9% year-over-year rise in the seasonally adjusted Manheim Used Vehicle Value Index.

CarMax, Inc. (KMX) is the biggest second-hand car retailer in the United States, while CarGurus, Inc. (CARG) is an online automotive marketplace that connects buyers and sellers through its platform. Founded in 1993, KMX is more than a decade older than CARG, which was founded in 2005. Given the former’s industry experience and operational scale, KMX stock increased significantly amid the COVID-19 pandemic and has become relatively overvalued versus CARG.

KMX has gained 176.8% over the past year, surpassing CARG’s 46.7% returns. In terms of year-to-performance also, KMX is the clear winner with 41.1% gains versus CARG’s negative returns over this period. However, in terms of profitability and other financial metrics, CARG appears to be a better investment bet. Let’s take a closer look.

Recent Developments

On January 29, CARG launched Finance in Advance to provide retail pre-financing services to customers, thereby easing the process of a car purchase. This digital retail financing feature is expected to boost the company’s turnover in the near term.

Earlier this month, CARG acquired a 51% equity stake in CarOffer, and plans to buy out the remaining stake over the next three years. The acquisition gives CARG  direct exposure to digital wholesale services, allowing dealers to buy and sell inventory online. As the automotive market gradually shifts online, this technology should allow CARG to ease the process of car sales across the country.

Last December,  KMX partnered with the NBA, WNBA, and Turner Sports and became  the official auto retailer for these teams. In the following month, KMX launched its “Love your car” guarantee, offering a 24-hour test drive and 30-day money back guarantee to all potential customers. Also,  the company offers a full refund for up to 1500 miles if a customer wishes to return a vehicle within the first 30 days. This move should allow KMX generate more  customers. It also plans to achieve carbon neutrality by 2050, with a 50% reduction in greenhouse emissions by 2025.

Recent Financial Results

CARG’s revenues from the ‘Advertising and Other’ segment have risen 4% year-over-year to $18.40 million in the fourth quarter ended December 31, 2020. Its non-GAAP operating income has increased 102.2% from its  year-ago value to $46.70 million, while its non-GAAP net income rose 89.1% from the same period last year to $36.50 million. Its non-GAAP EPS improved 83.8% year-over-year to $0.68.

KMX’s total revenues were  $5.18 billion in the fiscal third quarter, ended November 30, 2020, up 8.2% year-over-year. Its EBIT improved 36.4% from the same period last year to $310.50 million. And the company’s net earnings increased 35.9% year-over-year to $235.30 million over this period.

Past and Expected Financial Performance

CARG’s revenues and ebitda have increased at CAGRs of 20.3% and 81.8%, respectively, over the past three years. In comparison, KMX’s revenues have increased at a CAGR of 3.5% over the past three years, while its ebitda  declined 1.8% over this period. CARG’s net income has increased at a CAGR of 80.5% over the past years, while its EPS has risen at a CAGR of 77.5% over this period. KMX’s net income and EPS have increased at a CAGR of 2.7% and 6.8%, respectively, over the past three years.

CARG’s levered free cash flow increased at a rate of 93.8% over the past three years, while KMX’s levered free cash flow rose at a CAGR of 19.6% over this period.

CARG’s EPS is expected to rise 15.8% year-over-year to $0.22 in the current quarter ending March 2021. Its EPS is expected to rise at a rate of 27.4% per annum over the next five years. CARG has an impressive earnings surprise history also; it beat the Street’s EPS estimates in three  of the trailing four quarters. Consensus revenue estimates indicate a 23.7% improvement in fiscal 2021, and 15.5% rise next year.

In comparison,  KMX’s EPS is expected to decline 1.5% in the about-to-be-reported quarter, ended February 2021, and 15.6% in the current year. The company’s revenue is expected to decline 6.8% year-over-year to $18.93 billion in fiscal 2021. KMX also surpassed its  consensus EPS estimates in three  of the trailing four quarters.

Profitability

KMX’s trailing-12-month revenue is 36.05 times CARG’s. However, CARG is more profitable with a trailing-12-month gross profit margin of 92.43% versus KMX’s 14.57%.

CARG’s net income margin and levered free cash flow margin of 14.06% and 22%, respectively, compare favorably with KMX’s 3.78% and 2.88%, respectively. CARG is also more profitable in terms of trailing-12-month ROE (24.6% vs 19.21%) and ROTC (17.03% vs 3.31%) respectively.

Valuation

In terms of forward p/e, CARG is currently trading at 38.46x, 30.5% higher than KMZ, which is trading at 29.46x. However, KMX’s non-GAAP forward PEG ratio of 2.86 is 125.2% higher than CARG’s 1.27.

KMX is also more expensive in terms of trailing-12-month price/cash flow (28.89x vs 18.44) and trailing-12-month ev/ebitda (29.13x vs 23.28x).

POWR Ratings

CARG has an overall B rating, which equates to Buy in our proprietary POWR Ratings system, while KMX has an overall C rating, which translates to Neutral. The POWR Ratings are calculated by considering 118 different factors with each factor weighted to an optimal degree.

CARG has an A  grade  for Quality, which is in sync with the company’s impressive profitability. KMX has a D grade  for Quality, owing to its negative operating and net profit margins.

CARG has a Value grade of B, owing to its relative undervaluation. KMX, in comparison, has a C grade.

Of the 69 stocks in the Internet industry, CARG is ranked #3, while KMX is ranked #17 out of 25 stocks in the Auto Dealers & Rentals industry.

In addition to the grades we’ve  highlighted, our POWR Ratings system has also rated both CARG and KMX for Momentum, Stability, Sentiment and Growth. Get all CARG ratings here. Also, Click here to see the additional POWR Ratings for KMX.

The Winner

With a market capitalization value of $21.66 billion, KMX is a larger company than CARG. However, the company’s net income and EPS margins have increased nominally compared to CARG’s double-digit growth. Thus, at a relatively lower valuation, CARG’s projected earnings growth makes it a better investment now.

Our research shows that the odds of success increase if one  bets on stocks with an Overall POWR Rating of Buy or Strong Buy. If you’re looking for other top-rated stocks in the Auto Dealers & Rentals industry, click here. Also, you can view the top-rated stocks in the Internet industry here.

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CARG shares were trading at $25.10 per share on Monday afternoon, up $0.36 (+1.46%). Year-to-date, CARG has declined -20.90%, versus a 5.15% rise in the benchmark S&P 500 index during the same period.

About the Author: Aditi Ganguly

Aditi is an experienced content developer and financial writer who is passionate about helping investors understand the do’s and don'ts of investing. She has a keen interest in the stock market and has a fundamental approach when analyzing equities. More...

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