CarMax Is Up 43% -- Is It About to Drive Off a Cliff?

In the last three months, shares of used car retailer CarMax (KMX) - Get Report have gone into overdrive. Over that time the stock is up 29%. In the latest one-year period, the shares have risen nearly 43%.

But is this stock about to drive off a cliff and take investors with it?

On Thursday, CarMax held an analyst meeting to discuss the future of the company and used car sales. CarMax has come a long way since Richard Sharp founded the company in 1993. The company has managed to sell over 6.5 million used vehicles and 4 million wholesale vehicles, and it has completed 25.5 million appraisals.

With all those transactions, the company has collected vast amounts of proprietary data. CarMax is using the latest developments in data analytics to crunch over 180 million digital "interactions" per year, 500,000 customer surveys and 65 million in-store customer contacts into actionable intelligence.

The company is convinced the number-crunching helps customers find the right vehicle at the right price. That focus on technology allows CarMax sales associates to complete sales quickly and profitably.

Increasingly, customers are car shopping on their mobile devices. CarMax is working to make the shopping experience easier.

On Dec. 20, CarMax reported third-quarter fiscal 2017 earnings of 72 cents per share, a penny better than expected. Revenue rose 4.4% to $3.7 billion, vs. the $3.75 billion consensus figure.

Comparable sales increased 5.4%, compared to 3.1% last quarter and a 4.1% analyst estimate. Gross profit per used vehicle was flat.

In the quarter, the company opened six new locations and is on track to hit its goal of 15 new stores in fiscal 2017. Management plans to open between 13 and 16 new stores in fiscal 2018.

The average used car price was $19,520, down 2.9%, while gross dollar profit per vehicle of $2,155 declined just $5. Retail gross margin was 10.9%, up slightly from last quarter's 10.7%. Wholesale gross margins fell sequentially from 17.4% to 17%. Company-wide total gross margin ended the quarter at 13.6%. CarMax Auto Financing reported income of $89.4 million.

Going forward, investors are concerned about two issues. First, credit quality of auto buyers. CarMax bears say easy financing is driving auto sales and the company is benefiting from that trend. And second, investors are concerned about a flood of vehicles coming off lease as early as next year.

Analysts believe automakers have been pushing customers to lease vehicles by using the strong used car market to make the monthly payments artificially low. Some analysts estimate as much as 30% of new vehicle sales are on lease, and when those vehicles return to the dealer, the used car market could crash.

While these concerns are valid, they don't seem to be a factor right now.

I don't think CarMax will drive over a cliff just yet. Analysts are looking for CarMax to earn $3.29 this year, (up 4.2%) and $3.56 (up 6.7%) next year. In terms of valuation, CarMax is trading at 20 times this year's estimates and about 18.5 times next year's estimates. I think the shares can trade toward 20 times fiscal 2018 estimates of about $71 a share, but I would watch customer credit quality and the off-lease market, as they could derail my thesis.

This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.