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After missing earnings expectations last quarter, CarMax (KMX) bounced back with an EPS beat in Q1 as the used car dealership owner effectively managed expenses and bought back $100 mln in shares of common stock amid a difficult business climate. Those challenging business conditions, which include affordability issues due to high interest rates and tightened lending standards, once again weighed on demand, as reflected in a 3.8% decline in comparable store used unit sales.

• In regard to affordability issues, used car prices have indeed come down from the sky-high levels seen in the wake of the pandemic. According to CarGurus.com, the average used car price is down by more than 12% since June 2022, mainly thanks to a recovery in the supply of used cars.
• However, while KMX has lowered its prices a bit, it has chosen to avoid a deeper price war with its competitors in order to preserve margins. In Q1, KMX's average retail selling prices were down $700/unit, or 2.7%, which wasn't enough to jump start sales.
• Meanwhile, the company continues to have some struggles sourcing newer used vehicles. In particular, KMX is buying far fewer cars from consumers, who are more interested in new cars now that prices have cooled off. Therefore, consumers are increasingly trading in their cars to new car dealerships, leading to a 13.7% drop in vehicle purchases from consumers. This trend has caused KMX to turn to dealers, where the company accelerated its purchases by 70.8%. All told, though, KMX still purchased 8.6% fewer vehicles on a yr/yr basis.
• Based on the 3.7% decrease in retail used vehicle gross profit, it appears that finding used vehicles at attractive price points is even more challenging for KMX. Combined with the 7.5% sales decline, the margin contraction pushed EPS lower by 33% to $0.97.
• A clear bright spot was CarMax Auto Finance (CAF), which saw income grow by 7% yr/yr to $147.0 mln due to growth in average managed receivables and higher net interest margin. This side of the business benefits from higher interest rates, but KMX would gladly trade a little slower growth in CAF for a pullback in interest rates.

Overall, it was another difficult quarter for KMX, which finds itself between a rock and a hard place. If the company cuts prices further to become more competitive, its margins will take an even greater hit. However, if KMX keeps prices relatively higher, volumes will continue to sag, and it risks losing more market share.