Stock Picks: CarMax Up; Rite Aid Down

Investors got extra mileage out of CarMax (KMX) shares Tuesday after the used- and new-car retailer blew past Wall Street earnings estimates. Shares were up 8.4% in midmorning Tuesday trading.

The Richmond, Va.-based company said it earned 46 cents a share for the quarter ended Aug. 31, up from six cents a share a year ago. Wall Street analysts, on average, forecast earnings of 18 cents a share.

Used-car sales grew, the cash for clunkers rebate program boosted new-car sales and the company's finance unit became profitable — and all adding to the company’s bottom line, President and CEO Tom Folliard said in a Tuesday conference call. Acknowledging the role that the government incentives played in boosting sales in late July and August, Folliard added that “traffic had trended higher since late last winter, before the spike” from cash for clunkers.

Stacey Widlitz, an analyst at Pali Capital, upgraded the stock to Neutral from Sell and reversed a recommendation to hold the stock short. She said in a Tuesday note that the government incentive program pulled sales forward, meaning prospective buyers made purchases earlier than they may have planned, and that could create weakness later in the year.

Sam Yake, an analyst at BGB Securities, said the company wisely put its expansion plans on hold, and its latest sales pop bolsters the value of its fundamental business model. "While store openings have been temporarily suspended, CarMax is ideally positioned to resume growth once the economy begins to recover," he said.

Bottom Line: Hold
Wait for the giddy buying that follows an earnings beat to recede a little and think of this as a stock that will yield profitable long-term mileage.

Investors lowered their dosage of Rite Aid (RAD) shares ahead of the drug store chain's quarterly earnings on Thursday for the three months ended Aug. 29. The stock declined 5.8% in midday trading.

Raymond James analyst John Ransom downgraded the stock from Outperform to Market Perform. In a note to investors, Ransom said he doubted the Street’s expectation that Camp Hill, Pa.-based Rite Aid would narrow its loss to 16 cents a share from 27 cents a share a year ago. He also said that the company’s share price has been carried about as far as it can by the recent surge in stocks and that a revised operating strategy could help Rite Aid’s long-term health, but was unlikely to bear fruit in the short run.

"We believe the recent softening in sales trends, the likely increased near-term gross margin pressure, and its limited flexibility on investment spending (i.e., minimum prescription file buys) will likely limit any near-term upside,” wrote Ransom.

The downgrade comes in the wake of a government-mandated rollback of benchmark drug prices, which has sent ripples through health insurers and pharmacy benefit management companies. While most pharmacy benefit managers have said they are adjusting prices to minimize the impact, investors remain uncertain about all aspects of proposed health-care reform. That could cause stock prices in the sector to be more volatile in general. Coupled with uncertain prospects for retail sales, Ransom said he has low expectations for pending earning results, in spite of recent outperformance.

Bottom Line: Hold
Investors have been reducing short interest in the stock, buying into a general belief in an improved retail climate. If Rite Aid disappoints the drop may already be priced in based on today's decline, and long-term investors should be waiting for a more sustained recovery in any case.