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Carmax Hits A Pothole—And What It Means For Used-Car Buyers

No one in the world sells more used vehicles than Carmax. With more than 5 million cars and trucks moved every year, the chain is larger than its two closest competitors combined. Yet just this past week, Carmax took a financial hit, one that signals how the power in the used market has shifted.

Last week, Carmax reported a drop in quarterly profits (1.4% to $128 million) and a surprising decline in same-store sales (down 0.8%) despite a banner year for auto retailing, with new-vehicle sales near an estimated 17.8 million units.

Tom Folliard, the CEO of Carmax, blamed a lack of SUVs and heavy truck purchases in Carmax’s inventory at a time when low gas prices have lead to a severe change in what customers want in their next used car.

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“There was a chance that we could have paid more.” he said of the trucks and SUVs. “But we’re always trying to deliver a great value to the consumer as well. There are always times when certain [vehicles] are at the auction that we think are just too expensive.”

That along with cut-throat new car leasing prices, which are now less expensive than the average used car payment ($361 a month vs. $382 a month), are creating stiff winds for America’s most popular used-car dealer.

Unfortunately for Carmax, and their investors, the problems Carmax must face are far more daunting than a blip in supply and demand.

Most independent used car dealers such as Carmax get their inventory from wholesale dealer auctions that, on average, sell off close to 10 million vehicles every single year. These vehicles, which are mostly new car trades, off-lease models, and former rental vehicles, make up the bulk of Carmax’s inventory.

This supply of cars and trucks is the fuel that guides Carmax’s profit. If it buys the right vehicles, and minimize their repair and reconditioning costs (all those scuffs, dents, and chips that almost always need to be repaired), the company can realize a gross profit that is usually well in excess of $2,000 per vehicle.

The problem for Carmax and other used-car dealers outside the new-car business is that their supply to the most profitable vehicles is drying up. That’s due to three factors: Changing consumer demands due to low gas prices, a severe drop off in available vehicles, and franchise dealers keeping the best used vehicles for themselves.

Let’s say you’re leasing a 2012 Toyota 4Runner. When you bring your vehicle into a dealership at the end of a lease, you get the first crack at buying it outright. If you say no, the manufacturer of that vehicle will then offer it to the new car dealership at a set price.

If that Toyota 4Runner can fit the criteria of a certified pre-owned vehicle, the car dealership and the manufacturer have the opportunity to make thousands of dollars by reselling it to the public, instead of wholesaling it at a possible loss to independent used-car dealers.

Even if the dealership says no, Toyota can shop the vehicle online to other new car dealers who can say yes. This is where it gets tough for a company like Carmax. It isn’t until all the new-car dealerships have said no and the car has been run through what’s called a “closed sale,” where only new car dealers for that specific brand can bid on those vehicles, can Carmax then bid against other independent car dealers and get access to that popular vehicle.

And there just isn’t many of those vehicles out there.

The market for used trucks and SUVs has become enormously imbalanced due to abnormally low retail new sales from 2009 thru 2012 which were already down between 20% to 35% from the pre-recession average. This, along with high gas prices in 2010 thru 2014, further depressed the demand for new trucks and SUVs.

This scarcity of supply has a severe impact on Carmax’s bottom line, especially since they can’t easily acquire the off-lease inventory that is now in hot demand.

This low supply of high profit trucks and SUVs didn’t matter very much when gas was expensive. But now that crude oil prices have gone down by more than 60% over the past 18 months, the demand for SUVs and trucks has exploded. and it’s not the only segment that now represents a challenge for Carmax.

When a new market segment like crossovers becomes extremely popular, the used-car market has to wait several years for all those vehicles to become available. The demand for crossovers is becoming a question that Carmax simply can’t answer in their showrooms without substantially increasing their purchasing costs in the coming years.

Carmax suffered from fewer shoppers in its stores over the past several months due to all these marketplace changes. Yet its conversion rate, the process of turning a shopper into a buyer, improved substantially—and therein lies the elixir to Carmax’s current ills.

If the automotive behemoth can find the right ingredients to the used car buying recipe for consumers it will keep prospering in the years ahead. However, so long as gas is cheap, interest rates remain low, and access to the most popular cars remains a new-car dealer’s game, don’t expect Carmax to have any easy fight in today’s market.