CarMax - A Business Analysis

In a recent interview right here on GuruFocus, Tom Gayner of Markel (MKL) had a few things to say about CarMax (KMX). This prompted me to give the company a closer look. What follows is a business analysis. We will save considerations of stock analysis, such as price, for a later discussion.

I think that is a business that will continue to grow. I don't see any reason why you can't have a Carmax in a lot of towns way beyond what they're talking about right now. I think being the number one dealer, and having the number one market share in used car arena gives you great information on what transaction prices are. Then you work on the process to be as quick and as cost efficient in fixing the car and getting it sold, and have the confidence from customers when you offer warranties on the products. Those factors create a virtuous cycle. The more you do, the more you can do, the better the pricing is, the more the customers like you, the more your brand matters. The company will be around for a good long time. The management has done a very good job of creating the system and executing it.
CarMax was formed as a unit of Circuit City in 1993 and was spun off in 2002. Used-car sales account for about 80% of revenue. Competitors include, but certainly are not limited to, AutoNation (AN) and America's Car-Mart (CRMT) as well as private party sellers.

Five Forces Model Analysis

Threat of New Entrants: High fixed costs for inventory and access to channels of distribution are the largest barriers to entry for the industry. Economies of scale benefit the firm's competence but do not inhibit new entrants.

Intensity of Competition: From individual car owners to established car dealers, the industry is extremely competitive and customers are price-sensitive.

Bargaining Power of Suppliers: Suppliers have the potential capability to integrate forward in order to directly sell to customers.

Bargaining Power of Buyers: Customers are price sensitive, there are no switching costs, ! and options abound.

Threat of Substitutes: Alternatives exist but most people simply need a car.

Value Chain Analysis

Even though the used car industry is extremely competitive and price sensitive, CarMax does well because it has huge economies of scale. With large inventory, the company can spread its operating costs consistently across individual dealerships. CarMax adds value in five categories.

Acquiring Cars - Most of the cars are acquired through trade ins. This creates a high-quality inventory. CarMax offers a "while you wait" appraisal and gives you an offer that is valid for seven days. They also acquire cars through dealership relationships such as with auction houses.

Managing Inventory - This is the company's real competitive advantage. All inventory goes through a standardized internal inspection process. Cars are separated into "CarMax" and "Valumax" categories and sold through channels focusing on different categories of quality and price.

Operating Stores - Management policies guarantee a consistent customer experience across the company and inventory is shared nationwide.

Marketing and Selling - Website searching, "no haggle" price policy, and inspection guarantee are the key components of the companies value added strategy.

Services - The company differentiates itself from smaller dealers by offering financing, appraising, repairs, guarantees and warranties for every sale.

The process of inspecting and guaranteeing the quality of the cars CarMax re‐sells adds considerable value to the company's brand. This type of service is not likely to be found in other dealerships. The amount of resources that go into the value‐chain activity of managing and sorting CarMax's inventory is difficult to implement, and hard to imitate. While CARFAX Reports offer the same assurances of quality, they cannot offer the other benefits such as auto service and repairs, warranties and financing.

SWOT Analysis

Strengths - High quality vehicl! es, large! inventory, no haggle prices, customer friendly salesWeaknesses - High PricesOpportunities - Nationwide expansion, improved customer service, backwards integration to the supplier levelThreats - Overhead costs rise with each new store, poor economy, competition
While a poor economy hurts sales, this cuts both ways. In a truly robust market consumers might choose to purchase new cars, while a moderately slow economy encourages customers to trade down to used cars.

The biggest threat to this company is the "Best Buy" (BBY) problem. CarMax's website and transparent appraisal process make it an excellent place to go kick the tires and make an informed purchasing decision. The problem is that many customers will be making that purchase online from a lower-cost provider. Although CarMax's customer-centric shopping environment and service offerings provide some differentiation, I'm not convinced that price-sensitive customers will be willing to pay for the value-added services that CarMax provides.

According to this report, CarMax cars cost on average $2,000 more than the same car from a private party. The loan services, 7-day money back guarantee, 30-day warranty and guaranteed services after purchase are nice. Will customers continue to pay up for them?

Conclusion

At 2.5% market share CarMax is more than twice as large as the next closest competitor in the used car sales industry. With only 107 stores, CarMax is an enticing regional to national growth story with years of growth still ahead of it. On the downside, CarMax is the Best Buy of used cars — the place you go for a product demo before you buy online for less.

CarMax is a great growth story and it benefits from a network effect. CarMax offers the largest selection of used cars in the country. As this model attracts new purchasers, more of them sell their old cars to the company, which enhances the selection further and leads to still more customers. Longer term I think the price gap between CarMax and private partie! s will sh! rink as economies of scale take effect, thus strengthening the value added proposition.

CarMax has a compelling business model and should be able to grow by adding new stores.
Related links:Right hereTom Gayner

Will Time Warner Continue This Bullish Run?

With shares of Time Warner (NYSE:TWX) trading around $60, is TWX an OUTPERFORM, WAIT AND SEE or STAY AWAY? Let's analyze the stock with the relevant sections of our CHEAT SHEET investing framework:

T = Trends for a Stock’s Movement

Time Warner is a media and entertainment company. The company operates in three reporting segments: Networks, Film, and TV Entertainment and Publishing. Networks consist of television networks and premium pay and basic tier television services and digital media properties. Film and TV Entertainment consists of feature film, television, home video, and videogame production and distribution while Publishing consists of magazine publishing. Through its segments, Time Warner is able to move audiences around the world. With such a large and growing audience, look for Time Warner to continue to drive profits through its media and entertainment.

T = Technicals on the Stock Chart are Strong

Time Warner stock has just about tripled in price since early 2009. Currently, the stock is trading near a multi-year resistance level but any successful clearance of this level can send it soaring higher. Analyzing the price trend and its strength can be done using key simple moving averages. What are the key moving averages? The 50-day (pink), 100-day (blue), and 200-day (yellow) simple moving averages. As seen in the daily price chart below, Time Warner is trading slightly above its rising key averages which signal neutral to bullish price action in the near-term.

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(Source: Thinkorswim)

Taking a look at the implied volatility (red) and implied volatility skew levels of Time Warner options may help determine if investors are bullish, neutral, or bearish.

	Implied Volatility (IV)	30-Day IV Percentile	90-Day IV Percentile
Time Warner Options	22%	56%	52%

What does this mean? This means that investors or traders are buying a significant amount of call and put options contracts, as compared to the last 30 and 90 trading days.

	Put IV Skew	Call IV Skew
June Options	Flat	Average
July Options	Flat	Average

As of today, there is an average demand from call buyers or sellers and low demand by put buyers or high demand by put sellers, all neutral to bullish over the next two months. To summarize, investors are buying a significant amount of call and put option contracts and are leaning neutral to bullish over the next two months.

On the next page, let’s take a look at the earnings and revenue growth rates and the conclusion.

E = Earnings Are Increasing Quarter-Over-Quarter

Rising stock prices are often strongly correlated with rising earnings and revenue growth rates. Also, the last four quarterly earnings announcement reactions help gauge investor sentiment on Time Warner’s stock. What do the last four quarterly earnings and revenue growth (Y-O-Y) figures for Time Warner look like and more importantly, how did the markets like these numbers?

	2013 Q1	2012 Q4	2012 Q3	2012 Q2
Earnings Growth (Y-O-Y)	27.12%	57.94%	10.26%	-25.42%
Revenue Growth (Y-O-Y)	-0.57%	-0.35%	-3.20%	-4.07%
Earnings Reaction	-0.5%	4.1%	4.17%	1.22%

Time Warner has seen increasing earnings and decreasing revenue figures over the last four quarters. From these figures, the markets have generally been pleased with Time Warner’s recent earnings announcements.

P = Average Relative Performance Versus Peers and Sector

How has Time Warner stock done relative to its peers, News Corporation (NASDAQ:NWS), Walt Disney (NYSE:DIS), Comcast (NASDAQ:CMCSA), and sector?

	Time Warner	News Corp.	Walt Disney	Comcast	Sector
Year-to-Date Return	25.44%	27.36%	33.60%	11.83%	19.85%

Time Warner has been an average performer, year-to-date.

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Conclusion

Time Warner provides media and entertainment through a variety of mediums to consumers and businesses all around the world. The stock has tripled its prices in the last four years but is currently trading near a multi-year selling price level. Earnings have been increasing while revenue has decreased over the last four quarters which has kept investors happy. Relative to its strong peers and sector, Time Warner has been an average year-to-date performer. Look for Time Warner to OUTPERFORM.

The Evolution From Coins to Coffee, and Beyond

The Motley Fool is on the road in Seattle! Recently we visited Coinstar -- now officially renamed Outerwall  (NASDAQ: OUTR  ) -- to speak with CFO-turned-CEO Scott Di Valerio about the 22-year-old company's well-known coin-cashing machines, as well as its more recent acquisition of Redbox, and future initiatives to expand into other aspects of the automated retail market.

In this brief video segment Scott recounts the company's history, from the founder's frustrated attempt to exchange coins at a bank in the '90s to its partnership with McDonald's and eventual acquisition of Redbox, and where it may all lead in the future. The full version of the interview can be watched here.

A full transcript follows the video.

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Eric Bleeker: Hey, I'm Eric Bleeker, joined here by Scott Di Valerio, CEO of Coinstar or, soon to be "Outerwall," hopefully?

Scott Di Valerio: Yes.

Eric: Just wanted to check in with the metamorphosis of the business, because it is a truly intriguing business. Can you talk about how the company got started and progressed to the point it's at right now?

Di Valerio: You bet. Coinstar started around 22 years ago. Our founder was in grad school and had a whole bunch of coins, and was ready to go out one night and went to the bank to give them the coins so he could go out, and the bank said, "No, you need to roll all your coins," all those kind of good things.

He came back and did his senior thesis on how to get coins back into the marketplace in a more efficient and effective way, and then came back to Seattle and started Coinstar. Again, the rest is kind of history, from that perspective. We started with that Coinstar line of business, and continue to grow off of that.

The company did a number of acquisitions for a period of time, and one of those began a strategic partner with McDonald's, with Redbox. That was about eight years ago. We continued to increase our investment in Redbox over time, and then acquired them outright about four-and-a-half, five years ago and brought them up underneath the Coinstar brand.

We've been very excited about that, the marriage of both the coin line of business as well as the Redbox line of business, and then our ability to go out and continue to innovate in new businesses with Rubi, our coffee business, and we have four or five other small businesses that we're testing out; some that will work, some that won't, but again it's our history to be innovative, inventive, and to continue to try and grow out the business in new ways.

CAPScall of the Week: Intercept Pharmaceuticals

For years, satirical late-night TV host Stephen Colbert has been running a series on his show called "Better Know a District," which highlights one of the 435 U.S. congressional districts and its representative. While I am no Stephen Colbert, I am brutally inquisitive when it comes to the 5,000-plus listed companies on the U.S. stock exchanges.

That's why I've made it a weekly tradition to examine one seldom-followed company within the Motley Fool CAPS database and make a CAPScall of outperform or underperform on that company.

For this week's round of "Better Know a Stock," I'm going to take a closer look at Intercept Pharmaceuticals (NASDAQ: ICPT  ) .

What Intercept Pharmaceuticals does
Intercept Pharmaceuticals is a clinical-stage biopharmaceutical company focused on developing treatments aimed at chronic liver diseases. Specifically, Intercept differentiates itself through the utilization of its proprietary bile acid chemistry. The company's lead compound, known as obeticholic acid, or OCA, recently initiated phase 3 trials for primary biliary cirrhosis and has received orphan drug status from the Food and Drug Administration for this disease, which could ultimately expedite its review process and grant it seven years marketing exclusivity from the date of approval -- assuming it gets approved, of course! OCA is also being tested in a number of other indications.

In Intercept's most recent quarter, the company reported only $405,405 in licensing revenue while racking up a comprehensive loss of $10.5 million. Since inception, Intercept has an accumulated deficit of $128.7 million.

Whom it competes against
The allure of Intercept is that its OCA is angled at treating an aspect of PBC that currently has no FDA-approved treatment.

Geared as a secondary line of treatment, Intercept has geared OCA to snatch up patients who have an inadequate response to, or are unable to take, ursodiol, the only drug currently approved to treat PBC. Ursodiol was originally developed by Actavis (NYSE: ACT  ) (previously Watson Pharmaceuticals) but has since lost its exclusivity, with Lannett (NYSEMKT: LCI  ) gaining FDA approval to market generic versions of the drug in 2008. In the true sense of the word, Intercept has little direct competition as long as ursodiol intolerance exists in some patients.

The only direct competitor is Galectin Pharmaceuticals, a microcap biotechnology company that only received the OK from the FDA to begin human clinical trials for GR-MD-02 in March. That hasn't stopped Aegis Capital from coming down critically on Intercept, though, with Aegis commenting that, "OCA is unlikely to reverse liver fibrosis and that its safety profile may prove inferior to that of Galectin's GR-MD-02." 

The call
After carefully reviewing the prospects for Intercept Pharmaceuticals, I've decided to join the majority and make a CAPScall of underperform on the company.

The primary reason to be skeptical of Intercept is the same reason I'm often skeptical of clinical-phase biotechnology companies: It has no FDA-approved product, and it could be at least two years at the earliest before it does. In the meantime, Intercept has lost $128.7 million in the nearly 11 years since it began its operations and has financed its activities through dilutive secondary offerings. Two weeks ago, the company completed a 1.7 million share offering at $33.01 that helped raise approximately $53.3 million. While great news with the stock hitting new highs, more dilutive offerings should be expected with profitability still years away.

In addition, I have some skepticism surrounding OCA based on the small patient subset in phase 2 trials. Don't get me wrong, the 59-patient pool taking OCA demonstrated incredible results. Primarily, the reduction of alkaline phosphatase (AP) in the liver, an enzyme associated with liver disease progression, of 45% and 38% with the 10mg and 50mg doses compared to 0% with the placebo gives investors encouraging data to nibble on. But, phase 3 trials often bring with them the disappointment of considerably more tame results across a great subset of the population. This phase 3 trial is also going to be geared toward safety and longevity effects, which the phase 2 trial really didn't touch on. I'm not saying OCA has given any indications of being unsafe, but rather than investors are wrongly allotting a premium valuation to Intercept before the data is in.

Unless Intercept is able to hit all of its intended indications with OCA I simply can't see how today's valuation is justified.

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