America’s Car-Mart (CRMT) operates 151 used car dealerships in 12 states. It serves customers with impaired credit or minimal credit histories, explains Douglas Gerlach, editor of Investor Advisory Service — and a participant in the MoneyShow July 13-15 Virtual Expo.
As it retains the associated credit risk, Car-Mart’s business model is a hybrid between a car dealer and a consumer finance company. Selling used cars and financing them at high interest rates is not a very glorious market niche, but that is part of what makes Car-Mart so interesting.
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It specializes in a segment of the market that larger players avoid. Most competitors are mom-and-pop, single-shingle operators. Almost everybody needs a car, and Car-Mart is the best option available to some buyers.
The company has grown by steadily expanding its dealership network, very occasionally through acquisitions, and has lately concentrated more energy on growing dealership level productivity.
The company keeps a very conservative balance sheet. Excessive leverage could be deadly in an industry where economic downturns and interest rate fluctuations can cause rapid swings in customers’ ability to pay.
Car-Mart has been through many difficult periods in the past and maintains a capital structure that keeps it well out of harm’s way.
The current stimulus-rich consumer environment has been a huge boon to Car-Mart. Customers have used their stimulus payments to stay current on their car notes, and Car-Mart has experienced below-average default rates despite the pandemic’s damage to the jobs market and the economy overall.
A shortage of used car inventory has played into the company’s hands as well because customers have accepted price increases while the collateral on Car-Mart’s loan book has depreciated more slowly than credit models would have originally assumed. Investors seem to realize that growth and profitability are running ahead of their steady-state averages.
In the past four quarters, sales increased 23% while EPS more than doubled, yet shares sport a trailing P/E of just 10. Those are the kind of multiples you see at cyclical peaks. Growth is capital intensive because it takes time for an incremental vehicle to transition from inventory, to a loan receivable, to cash receipts on that loan.
Nonetheless, the company has consistently generated positive free cash flow, while also growing sales revenue 8% per year over the past ten years. The main use of incremental borrowing has been to buy back shares. Car-Mart has reduced its diluted share count by an astounding 20% over the past five years.
The triumvirate of revenue growth, operating leverage, and a declining share count has caused EPS to increase more than 17% annually during that span, although we note that current profitability is likely exaggerated in this environment.
Historically, the company’s greatest struggles have come when investor money floods into subprime auto financing, enabling larger dealers to compete more aggressively for Car-Mart’s target customer.
These waves of subprime lending eventually crash on the rocks of credit losses, but before the inevitable crash Car-Mart endures a phase where competition goes from aggressive to outright irrational— hence the need for a correction. It is dangerous to compete against lenders who court credit losses.
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A new generation of online-only used car dealers presents a new competitive threat. If any of these well-financed companies turns its full attention to the subprime consumer, then Car-Mart’s competitive position could suddenly be at the mercy of a competitor’s bull market investor base who worship revenue growth at any accompanying level of profit or loss.
We model 10% compound EPS growth, which could generate EPS of $24.08 in five years. That figure, combined with a high P/E of 17.4, generates a high price of $419.
For a low price, we apply a low P/E of 7.5 to EPS of $10, a round number that looks like a reasonably conservative decrement to current blowout earnings. This yields a low price of $75. On that basis, the upside/downside ratio is 3.8 to 1.
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