CarMax: Tariffs Support Q1 But Credit Headwinds Persist (Upgrade)
Summary
CarMax reported a strong Q1 beat driven by higher volumes and margins, partly due to tariff pull-forward. However, financing profits are pressured by rising credit losses requiring increased provisioning, which is expected to weigh on future earnings. Despite credit headwinds, improved cost controls and recent underperformance bring shares near fair value, suggesting a balanced risk/reward. The stock is upgraded to Neutral.
CarMax: Tariffs Support Q1 But Credit Headwinds Persist (Upgrade)
Related Stock: KMX
CarMax (KMX) delivered a surprisingly strong performance in the first quarter of fiscal year 2026, exceeding analyst expectations with a notable beat on both revenue and earnings. The company reported higher vehicle volumes and achieved record gross profit per unit, contributing significantly to the positive results. This strong showing was partly attributed to a pull-forward effect from anticipated tariffs, which encouraged some customers to accelerate their vehicle purchases.
While the top-line performance was robust, a closer look at the financials reveals persistent challenges within CarMax's financing segment. The company's financing profits continue to be pressured by rising credit losses. As economic conditions remain uncertain and interest rates stay elevated, a portion of CarMax's customer base is experiencing increased difficulty in meeting their loan obligations. This trend necessitates higher provisioning for potential loan losses, which acts as a drag on the company's overall profitability.
Looking ahead, the impact of these credit headwinds is expected to continue weighing on future earnings. While CarMax has implemented cost control measures and improved operational efficiency, the need for ongoing provisioning against potential loan defaults will likely temper the benefits of these initiatives. The company's ability to manage credit risk effectively will be a critical factor in its financial performance over the coming quarters.
Despite the challenges in the financing arm, CarMax shares have recently experienced a period of underperformance, bringing their valuation closer to what I consider fair value. The recent price action, combined with the company's demonstrated ability to control costs and the temporary boost from tariff-related demand, suggests a more balanced risk/reward profile for the stock at current levels. While the credit environment remains a concern, the operational improvements and the potential for continued market share gains in the used car market provide some offsetting positives.
From an investment perspective, the Q1 results highlight the dual nature of CarMax's business: a resilient retail operation capable of navigating market shifts and a financing arm susceptible to macroeconomic pressures. Investors should monitor the trends in credit losses and the company's provisioning levels closely. While the tariff-driven boost in Q1 is unlikely to be a recurring theme, the underlying strength in retail volumes and margins, coupled with cost management efforts, provides a foundation. However, the persistent credit headwinds warrant caution and temper the overall outlook. The current valuation appears to reflect a degree of these mixed signals.
Considering the recent underperformance and the Q1 beat, albeit with caveats, I am upgrading my view on CarMax shares to Neutral. The stock now trades near my fair value target, reflecting a more balanced assessment of the opportunities and risks. The key factors to watch will be the trajectory of credit losses, the effectiveness of provisioning strategies, and the sustainability of retail volume and margin performance in a potentially less favorable tariff environment.