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How Off-Lease Autos Drive Gains at CarMax

The US car market faces a tidal wave of cars coming off-lease during the next few years.

Image via Ildar Sagdejev/Wikimedia

The US car market faces a tidal wave of cars coming off-lease during the next few years. Since 2010, new-car leases have gained popularity, reaching as much as one-third of all US auto sales, observes Elliott Gue, editor of Capitalist Times.

However, there’s a hangover from all these leased vehicles; the soaring popularity of leases over the past three to five years spells a record number of off-lease vehicles entering the U.S. used-car market. A record 3.6 million cars came off-lease this year, with a further 4.1 million due off lease next year and 4.3 million in 2019.

The supply has pushed down used car prices, and the increase in newer model used cars competes with new cars for consumers’ attention. Even worse, falling used-car prices impairs the economics of leasing over time.

Just consider, when you lease a vehicle for 36 months, the seller assumes a residual value for the car after 3 years. You’re financing the difference between the cost of the new car and its assumed value after 36 months. However, if used car values decline, so do assumed residual values. The result: lease terms erode.

This is bad news for companies exposed to the new-car market. But it represents a windfall for used-car retailer CarMax (KMX), the largest used-car retailer in the U.S. and a pioneer of the no-haggle pricing model–consumers can trade in their old cars, buy a used vehicle and secure financing and a warranty without ever negotiating with a salesman.

Moreover, because CarMax has a vast national inventory of used cars available, consumers have a much greater selection. With used-car prices falling and a vast supply of relatively new, low mileage used vehicles coming off-lease over the next few years, CarMax should benefit. That’s because many consumers will opt for a used vehicle rather than paying up for a new car under less attractive lease or financing terms.

These trends already show in CarMax earnings. In late September, CarMax announced earnings of $0.98 per share, comfortably above expectations for $0.95. Even more important, comparable store sales–sales from locations open for more than a year–jumped 5.3 percent while total revenues rose more than 11 percent, boosted by new store openings.

Bears argue that CarMax will face headwinds as used-car prices fall. However, CarMax turns over its inventory rapidly. As a result, while the sticker prices of used cars CarMax sells declines in line with the used car market, so is the company’s acquisition cost for buying new inventory.

As a result, the company has managed to keep the gross profit per unit sold constant over the past couple of years, even as used-car prices fell sharply. We are adding the stock to our Wealth Builder Portfolio.

Elliott Gue is editor of Capitalist Times.

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