Used car retailers have felt the pressure of high inflation and rising interest rates since last year. While consumer prices rose at the slowest pace last month since May 2021, inflation still remains above the Fed’s comfort zone.

The Fed will likely keep raising interest rates until it achieves its long-term inflation target. This will likely heap more pressure on used car retailers that were already struggling with softening sales and dropping prices. Therefore, it could be wise for investors to avoid fundamentally weak stocks CarMax, Inc. (KMX - Get Rating) and America’s Car-Mart, Inc. (CRMT - Get Rating).

Before diving into why these stocks are unlikely to make it through this month, let’s discuss what’s happening in the used car industry.

The used car industry benefited immensely post the pandemic as automakers halted or slowed down new vehicle production due to supply chain disruptions, labor shortages, and other factors. High demand for pre-owned vehicles led to a jump in their prices.

However, used car businesses have been hit by the challenges of tighter consumer spending amid high inflation and rising interest rates. In addition, easing the supply chain issues meant that new vehicle production was back on track, and waiting times were drastically reduced.

Cox Automotive’s senior manager of economic and industry insights, Chris Frey, said, “After a huge run-up in 2021, last year was a reality check. The used market now faces a challenging year as demand weakens.” Cox Automotive believes used-car values will fall more than 4% this year.

With significant inventories and falling prices, used car retailers have no choice but to sell the vehicles for less than what they had paid. Moreover, the likelihood of more interest rate hikes and a recession will likely put even more pressure on used car businesses.

Given these factors, it could be wise to avoid fundamentally weak stocks KMX and CRMT.

Let’s discuss these stocks in detail.

CarMax, Inc. (KMX - Get Rating)

KMX operates as a retailer of used vehicles in the United States. KMX is known for its no-haggle pricing policy, which offers customers a transparent and straightforward way to purchase a vehicle. The company operates through two segments, CarMax Sales Operations and CarMax Auto Finance.

In terms of forward non-GAAP P/E, KMX’s 33.70x is 138.1% higher than the 14.16x industry average. Its 31.13x forward EV/EBITDA is 229.1% higher than the 9.46x industry average. Likewise, its 52.84x forward EV/EBIT is 308.6% higher than the 12.93x industry average.

For the fiscal fourth quarter that ended February 28, 2023, KMX’s net sales and operating revenues declined 25.6% year-over-year to $5.72 billion. The company’s gross profit declined 14.1% year-over-year to $610.98 million. Its net earnings declined 56.8% year-over-year to $69.01 million. Additionally, its net EPS came in at $0.44, representing a 55.1% decline from the prior-year quarter.

Analysts expect KMX’s EPS and revenue for the quarter ending May 31, 2023, to decrease 45.5% and 18.8% year-over-year to $0.85 and $7.57 billion, respectively. Over the past year, the stock has fallen 30% to close the last trading session at $72.21.

KMX’s bleak fundamentals are reflected in its POWR Ratings. The stock has an overall rating of D, which equates to a Sell in our proprietary rating system. The POWR Ratings assess stocks by 118 different factors, each with its own weighting.

It is ranked last out of 21 stocks in the Auto Dealers & Rentals industry. Additionally, it has an F grade for Growth and Sentiment and a D for Stability and Quality. We have also given KMX grades for Value and Momentum. Get all KMX ratings here.

America’s Car-Mart, Inc. (CRMT - Get Rating)

CRMT operates as an automotive retailer in the United States. It primarily sells older model used vehicles and provides financing for its customers.

In terms of forward non-GAAP P/E, CRMT’s 22.36x is 58% higher than the 14.16x industry average. Its 15.91x forward EV/EBITDA is 68.1% higher than the 9.46x industry average. Likewise, its 35.38x forward EV/EBIT is 173.6% higher than the 12.93x industry average.

CRMT’s net income attributable to common shareholders for the third quarter ended January 31, 2023, declined 92.2% year-over-year to $1.50 million. Its total costs and expenses increased 24% year-over-year to $324.77 million. Moreover, its EPS came in at $0.23, representing a 91.8% decline from the year-ago quarter.

CRMT’s EPS for the quarter ending April 30, 2023, is expected to decline 71.8% year-over-year to $1.13. It has a bleak earnings surprise history, missing its consensus EPS estimates in three of the trailing four quarters. Over the past nine months, the stock has fallen 10.9% to close the last trading session at $83.41.

CRMT’s POWR Ratings reflect grim prospects. The stock has an overall rating of D, equating to a Sell in our proprietary rating system.

It is ranked #19 in the same industry. The stock has an F grade for Sentiment and a D for Growth and Stability. Click here to see the additional ratings of CRMT for Value, Momentum, and Quality.

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KMX shares were trading at $68.20 per share on Wednesday afternoon, down $4.01 (-5.55%). Year-to-date, KMX has gained 12.01%, versus a 7.28% rise in the benchmark S&P 500 index during the same period.

About the Author: Malaika Alphonsus

Malaika's passion for writing and interest in financial markets led her to pursue a career in investment research. With a degree in Economics and Psychology, she intends to assist investors in making informed investment decisions. More...

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