Could falling car sales cause problems for this Warren Buffett stock?

People don’t spend like they used to. High inflation and rising interest rates are changing how people spend their money.

CarMaxit is (NYSE: KMX) the latest results show how people felt the pressure of inflation as it missed earnings estimates and issued a warning to investors. Vehicle affordability and weak consumer confidence weighed on the company’s earnings, and its shares fell nearly 25% after its Sept. 29 earnings call.

Allied Financial (NYSE: ALLY) is one of the largest full-service auto lenders in the United States and is a stock that Berkshire Hathaway CEO Warren Buffett continues to stack during this bear market. Allied investors may wonder if CarMax’s disappointing earnings are causing trouble for the lender. Here’s what you need to know.

Consumers prioritize their spending differently

CarMax recently reported disappointing results and missed estimates as it posted $8.1 billion in revenue, compared to $8.5 billion for analysts. Earnings per share were $0.79, well below estimates of $1.39. Demand for used vehicles was weak during the quarter due to low consumer confidence, vehicle affordability and rising interest rates.

CarMax CEO Bill Nash said, “I just think consumers are prioritizing their spending a little differently” and added, “I think it’s just a continuation of the deterioration of the overall consumer.” He said inflation increases the costs of a wide range of products and as a result consumers favor small purchases over larger ones. That and higher interest rates make financing a used vehicle more expensive.

The company expects weak sales to continue for at least another quarter, but its growth could be under pressure for a few quarters if economic conditions do not improve.

Ally has this edge that could help her weather the slowdown in demand

Ally Financial is a leading automotive lender, generating 65% of its revenue and 90% of its pre-tax profit. The bank has 22,400 dealer relationships across the United States

During its second-quarter earnings, it reported auto mounts of $13.3 billion — its highest level since 2006 and its eighth straight quarter of net finance income growth. At the time, the company said consumer demand was healthy and it expected it to remain robust.

Image source: Getty Images.

There’s a good chance Ally will see its auto finance revenue slow when it announces its results on Oct. 19. However, Ally might be better positioned than CarMax because of the customers it serves.

Daniel Imbro, managing director of Stephens Inc. which covers CarMax and other auto retailers, said the drop in demand was “almost solely due to affordability issues”. The population most affected by inflation is those in a lower income bracket, for whom food and housing costs represent a larger share of their monthly expenses.

Ally focuses on high-income segments of the population that make up most of its lending. The average income of its consumers is $100,000, and CFO Jenn LaClair told investors in July that “we don’t see a slowdown from a demand perspective” from those customers.

Ally stock hasn’t been this cheap in years

Ally should have no problem weathering a downturn and its balance sheet is strong. The bank has over $3.7 billion in cash equivalents and total liquidity, including highly liquid securities and over $28 billion in unused borrowing capacity.

The stock is trading at a cheap valuation with a price-to-earnings (P/E) ratio of 4.4, which is below its 10-year average. It is also trading below book value, with a tangible price-to-book value ratio of 0.88, giving investors what appears to be a margin of safety.

Ally could see its auto loan business slow in the coming quarters. However, its focus on high-income earners could shield it from some of the affordability issues that have dampened demand in the industry.

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Ally is an advertising partner of The Ascent, a Motley Fool company. Courtney Carlsen has no position in the stocks mentioned. The Motley Fool holds positions and recommends Berkshire Hathaway (B shares). The Motley Fool recommends CarMax and recommends the following options: $200 long calls in January 2023 on Berkshire Hathaway (B shares), $200 short put options in January 2023 on Berkshire Hathaway (B shares) and short calls of $265 in January 2023 on Berkshire Hathaway (B shares). The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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