August 21st, 2015 Analyst: redcards

LONG | CarMax, Inc. | NYSE: KMX Basic Data Scenario Analysis

Price (8/21/15) $59.58 3-Month Avg. Vol. 1,460,080 Market Cap $13.2b Enterprise Value $16.3b

Capital Structure Considerations

$300m of long-term debt at 1.6% interest (expiring 11/17) and 0.2x net debt/EBITDA ratio. Investment Thesis

Sentiment on the subprime auto ABS market is too bearish. The Street ignores the outperformance of KMX’s auto loans benefiting from an increasing origination rate driven by consensus expectations of modest retail gross profit expansion as store base grows 45%.

KMX’s auto loans offer an asymmetric risk/reward opportunity as auto ABS are not capitalized with subprime credit or the Company’s balance sheet. ABS credit metrics have best-in-class risk performance of < 2% net losses and 5% spread capture on an average 7% loan.

Management is overtly conservative. Overcollateralization reserves are guided at filling 3-4 months after issuance, but are completed sooner at 1.5 months, allowing for quicker net cash flow capture of high quality credit and contributes to a 14% ABS cash flow CAGR.

A 9.6% average FCF yield is efficiently allocated by management. $2.25b worth of shares will be reacquired through 2016 under current buyback plan, and will drive a low-to-mid teens compounding return over the next 5 years.

Key Sensitivities Scenario Details

Catalysts

Key Risks and Mitigants

Subprime financing test exposes KMX to bad credit: Subprime auto loans are financed with the Company’s balance sheet and do not threaten securitization performance. Subprime loans make up 1.3% of total receivable balance.

Cash flow from auto loans is not immediate upon issuance: There is a 1.5-month gap between loan overcollateralization target being filled and net cash flows received on new auto loans – KMX does not book these cash flows until they are received.

Financing origination is sensitive to interest rate environment: Attractive bank financing rates on securitizations combined with increasing interest rates allows spread capture to remain constant at 5%.

Financials

1

Effect on Spread Capture

0.1% 1.1% 2.1% 3.1% 4.1%

5.2% 5.1% 4.1% 3.1% 2.1% 1.1%

6.2% 6.1% 5.1% 4.1% 3.1% 2.1%

7.2% 7.1% 6.1% 5.1% 4.1% 3.1%

8.2% 8.1% 7.1% 6.1% 5.1% 4.1%

9.2% 9.1% 8.1% 7.1% 6.1% 5.1%

Effect on Used Gross Profit per Unit

8.5% 9.5% 10.5% 11.5% 12.5%

10.0% 2,193.2 2,173.1 2,153.5 2,134.1 2,115.211.0% 2,233.2 2,212.8 2,192.8 2,173.1 2,153.8

12.0% 2,273.6 2,252.9 2,234.2 2,212.5 2,192.8

13.0% 2,314.4 2,293.3 2,272.5 2,252.1 2,232.1

14.0% 2,355.6 2,334.0 2,312.9 2,292.2 2,271.8

Gross Profit

Growth

Auto Loan

Interest Rate

Bondholder Payout

Vehicle Unit Growth

Continuation of share repurchase program beyond 2016P.

Continued outperformance of ABS vs. subprime competitors.

Bear Case Base Case Bull Case

Capex ($mm) -58.1 -38.7 -15.5

Shares outstanding (mm) 208.8 176.9 165.0

FCF yield 7.7% 9.6% 10.5%

IRR -1.6% 7.7% 13.0%

Projected 2017 estimates

Bear Case Base Case Bull Case

Free cash flow ($mm) 958.5 1,016.6 1,032.1

FCF per share $4.59 $5.75 $6.26

P/FCF multiple 12.0x 15.0x 17.5x

Share price $55.08 $86.20 $109.55

Upside/downside -7.6% 44.7% 83.9%

Projected 2017 estimates

($ in millions) 2013 2014 2015 2016E 2017P 2016E 2017P

Revenues 10,962.8 12,574.3 14,268.7 15,746.7 17,307.1 15,569.7 17,175.2

Gross margin 13.4% 13.1% 13.2% 13.6% 13.6% 13.4% 13.5%

Net income 434.3 492.6 597.4 669.5 725.3 639.2 689.2

Profi t margin 4.0% 3.9% 4.2% 4.3% 4.2% 4.1% 4.0%

Earnings per share $1.87 $2.16 $2.73 $3.78 $4.04 $3.07 $3.47

Analyst Estimates Consensus

August 21st, 2015 Analyst: redcards

Why Does This Opportunity Exist?

Financial databases miss KMX’s cash generation: Cash flow from securitization transactions are recorded as financing cash flow, and is not included in CFO/FCF calculations on automated financial terminals such as Bloomberg, Capital IQ, and FactSet.

Auto securitization performance is buried in the weeds: The low risk performance details of auto loan securitizations are buried within the fine print of KMX’s complex securitization prospectuses that many investors simply do not take the time to read.

Market sell-off: KMX is currently trading 15% down from its 52-week high of $73.70 after an analyst comps estimate miss for Q1 earnings prompted an irrational sell-off.

Debunking the Bear Thesis

Cash flow from securitization issuance is unsustainable: Net cash flow from securitizations is collected up front at the time of transaction with special purpose entity, and is not tied to cash flow from spread capture.

Time-to-maturity of loans is too long to wait for cash flows: The tiered payout structure of KMX’s auto securitizations results in the 50% payback of a $1.2b loan with a 5.5-year time-to-maturity within the first 24 months.

Subprime financing test adds too much risk to balance sheet: KMX gets first look at customer profiles for financing, and can still refer risky subprime customers to bank partners if the risk of loan default is too high for on-balance sheet financing.

KMX Would Be a Short If…

CarMax Auto Finance (CAF) was spun off: KMX would lose a strong source of cash flow and revert to lower margin gain on fees from financing referrals to third party banks as well as if the Company abandoned self-financing completely.

Auto loan spread capture fell below 3%: Loan performance would fall in-line with new car loans and no longer present an attractive return profile compared to the same best-in-class auto loans of Ford and Toyota.

Auto loan securitizations began capitalizing with subprime credit: KMX’s auto loan securitizations would no longer have a competitive edge in the ABS market if they were capitalized with subprime credit and would lose their asymmetric risk/reward profile.

Valuation I valued KMX on 2017P FCF. A composite of high quality American and Chinese automotive retailers, manufacturers, lenders, and auctioneers trade at an average 15x FCF. My base case 15x FCF scenario both embeds conservatism and margin of safety into the expected IRR considering KMX currently trades at 10x 2017P FCF.

2

$59.58

$86.20

$109.55

$55.08

$0.00

$20.00

$40.00

$60.00

$80.00

$100.00

$120.00

Today Base Bull Bear

KMX Valuation Scenarios

Upside / Downside 45% 84% -8%

FCF per share $5.75 $6.26 $4.59

FCF multiple 15.0x 17.5x 12.0x

IRR 7.7% 13.0% -1.6%

Free Cash Flow Yield

2016E 2017P 2018P 2019P 2020P

Free cash flow ($mm) 743.2 1,016.6 954.1 1,210.6 1,250.6

Shares outstanding (mm) 208.8 176.9 176.9 176.9 176.9

Free cash flow per share $3.56 $5.75 $5.39 $6.84 $7.07

Free cash flow yield 6.0% 9.6% 9.1% 11.5% 11.9%

CarMax Retail 2015 2017P CAGR

Retail units 590,224.0 720,706.4 10.5%

Retail average selling price (ASP) 23,585.5 23,803.9 0.5%

Retail gross profit per unit (GPU) 2,840.8 2,993.0 2.6%

CarMax Auto Finance (CAF) 2015 2017P CAGR

Interest and fee income ($mm) 604.9 852.9 18.7%

CAF income ($mm) 367.3 546.0 21.9%

Non-recourse notes payable, net ($mm) 1,222.2 1,742.2 19.4%

Auto Loan Securitizations 2015 2017P CAGR

Average interest rate 7.1% - -

Bondholder payout 2.1% - -

Spread captured 5.0% - -

Return on invested capital (ROIC) 29.0% - -

FCF Multiple

2017P FCF per share $5.75 10.0%

Applied FCF multiple 15.0x 3.0%

Price target $86.20 16,304.2

Upside / downside 44.7% 259.8

IRR (Present to 2017P) 7.7% 16,044.4

176.9

$90.70

52.2%

8.8%

Base Case Drivers

Base Case Methodology

Discounted Cash Flow

WACC

Long-term growth

Upside / downside

IRR (Present to 2017P)

Enterprise value ($mm)

Net debt ($mm)

Equity value ($mm)

Shares out. (mm)

Price target

August 21st, 2015 Analyst: redcards

Appendix I: Thesis and Risk Details CarMax, Inc. is a growth story the Street has been familiar with for some time. The Company is attractively positioned within its industry to take advantage of scale economics of an end product that is not fungible, and has small market share that could grow indefinitely driving superior returns on invested capital. However, the current KMX thesis is only half-baked and does not fully recognize the value proposition of their self-financing business.

The growth thesis for KMX is fairly straight forward. The Company is the leading consolidator of the used car retail market, and is expected to compound their market share by expanding into untapped markets, while retaining their current customer base due to the unique no-haggle value proposition of the KMX business model.

KMX currently operates 145 stores in 30 states and plans on expanding their store base to over 200 stores nationwide over the next five years.

To drive this potential for growth home, consider the following:

KMX stores only reach about 63% of the U.S. population, and;

KMX only captures 3% market share of the used car retail industry. At only 3% market share capture, KMX has generated $14b in revenue for the most recent year. In this market, there are few companies with the national scale that CarMax has, including – AutoNation, Group 1 Automotive, Penske Automotive Group, and Sonic Automotive. The industry is highly fragmented because most dealerships are not part of a much larger group. While there are above 17,000 new car dealerships in the country, the number of used car dealerships is higher toward 35,000. Despite CarMax’s 3% market share, the Company still sells twice as many vehicles as the next-largest retailer of used cars, AutoNation.

The success of KMX’s business model is driven by the fact that the Company offers consumers a used vehicle purchase process that is fundamentally different from a typical auto retail experience. There is a no-haggle pricing model which removes a universal frustration from consumers, also, KMX sales consultants are paid commissions on a fixed dollars-per-unit basis which means salesmen have no incentive to push consumers toward a higher priced vehicle, or try and pass a higher interest rate by.

3

Store Growth

2016E 2017P 2018P 2019P 2020P

Number of stores:

Stand-alone new car 1 1 1 1 1

Used car superstore 158 172 186 198 209

Total 159 173 187 199 210

New stores 14 14 14 12 11

August 21st, 2015 Analyst: redcards

Growth of CarMax’s store base and presence into new markets will drive the expansion of total used vehicle revenues and retail units sold through 2020P at a 10% CAGR.

The Manheim Used Vehicle Value Index serves as an indicator for volatility in the price of used vehicles. Since 2005, the annual average has grown at a 2.2% CAGR. By conservative estimates, CarMax’s retail ASP should grow at a similar rate as it tracks the index.

Together, unit and retail ASP growth contribute as the two drivers of a 9.4% gross profit CAGR through 2020P. Over the next five years, gross profit growth should drive a modest 1.8% CAGR expansion of used vehicle gross profit per unit, the excess spread KMX earns on vehicle transactions.

Instead of chasing high spreads with unsustainable ASP increases and damaging KMX’s reputation for fair prices, management focuses on capturing market share and driving unit growth, and this makes it riskiest to retail spread.

4

0.0

100,000.0

200,000.0

300,000.0

400,000.0

500,000.0

600,000.0

700,000.0

800,000.0

900,000.0

1,000,000.0

2010 2011 2012 2013 2014 2015 2016E 2017P 2018P 2019P 2020P

Tota

l Un

its

Sold

KMX Retail Units Growth

0.0

5,000.0

10,000.0

15,000.0

20,000.0

25,000.0

2010 2011 2012 2013 2014 2015 2016E 2017P 2018P 2019P 2020P

Re

ven

ue

($

in m

m)

KMX Used Vehicle Revenues

90.0

95.0

100.0

105.0

110.0

115.0

120.0

125.0

130.0

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Jan

uar

y 1

99

5 =

10

0

Manheim Used Vehicle Value Index, July 2015

18,000.0

19,000.0

20,000.0

21,000.0

22,000.0

23,000.0

24,000.0

25,000.0

2010 2011 2012 2013 2014 2015 2016E 2017P 2018P 2019P 2020P

Re

tail

ASP

($

)

KMX Retail ASP Growth

0.0

500.0

1,000.0

1,500.0

2,000.0

2,500.0

3,000.0

3,500.0

4,000.0

2010 2011 2012 2013 2014 2015 2016E 2017P 2018P 2019P 2020P

Gro

ss P

rofi

t ($

in m

m)

KMX Gross Profit Growth

1,850.0

2,000.0

2,150.0

2,300.0

2,450.0

2010 2011 2012 2013 2014 2015 2016E 2017P 2018P 2019P 2020P

Gro

ss P

rofi

t p

er

Un

it (

$)

KMX Used Vehicle Gross Profit per Unit Growth

Effect on Used Gross Profit per Unit

8.5% 9.5% 10.5% 11.5% 12.5%

10.0% 2,193.2 2,173.1 2,153.5 2,134.1 2,115.2

11.0% 2,233.2 2,212.8 2,192.8 2,173.1 2,153.8

12.0% 2,273.6 2,252.9 2,234.2 2,212.5 2,192.8

13.0% 2,314.4 2,293.3 2,272.5 2,252.1 2,232.1

14.0% 2,355.6 2,334.0 2,312.9 2,292.2 2,271.8

Gross Profit

Growth

Vehicle Unit Growth

August 21st, 2015 Analyst: redcards

KMX’s successful gross profit performance has also driven an increasing penetration rate of loans financed through KMX’s financial service, CarMax Auto Finance (CAF) from 32% to 41%. Subsequently, total auto loan receivable balance has grown from $4.1b to $8.4b.

CAF income has growth at a 16% CAGR over the same period, but Wall Street has not fully appreciated this business due to its perceived riskiness in relation to the subprime auto loan market. Increased supply and demand of auto loan-backed ABS has begun to make Wall Street nervous that the ABS market has entered “bubble territory”. Bank of America Global Research estimates that supply should come in at around $125b this year, up 25% from 2014 and accounts for more than half of total consumer loan-backed issuance. Notably worrying is the trend of subprime loan origination vastly outpacing the origination of safer prime loans. (Source: Goldman Sachs Research).

The fear is that as demand continues to build, competition among underwriters increases, and as a result borrowers who never should have been given loans in the first place start to default and the ABS collateral pools quickly transform from collections of quality credit to collections of bad credit.

Data collected from Experian (Q1’15 data) shows several ABS metrics that have reached an all time high: Average loan term for new cars is now 67 months. Average loan term for used cars is now 62 months. Loans with terms from 74 to 84 months made up 30% of all new vehicle financing. Loans with terms from 74 to 84 months made up 16% of all used vehicle financing. 5

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

45.0%

50.0%

2010 2011 2012 2013 2014 2015

Pe

ne

trat

ion

Rat

e

KMX Financing Penetration Rate

0.0

1,000.0

2,000.0

3,000.0

4,000.0

5,000.0

6,000.0

7,000.0

8,000.0

9,000.0

2010 2011 2012 2013 2014 2015

Au

to L

oan

Re

ceiv

able

s ($

in m

m)

KMX Auto Loan Receivables

August 21st, 2015 Analyst: redcards

Bearish Wall Street research points out that losses on car loans taken out by bad-credit borrowers are continuing to climb, and attributes this phenomenon to an increase in the number of “rookie” auto finance companies that have entered the market in recent years. As a result, the second and third largest players in the auto loan market, Capital One and GM Financial, are seeing the highest loss and delinquency ratios since the crisis (Source: Goldman Sachs Research).

The Street’s negative sentiment that surrounds anything with exposure to the auto loan ABS market ignores KMX as one of the safest competitors in the space. KMX does not securitize subprime credit, and the performance profile of the Company’s auto loans offer a best-in-class risk/reward profile. Unlike the leading issuers of used car loans, KMX’s auto loans perform with the delinquency and net loss rates of the best in class issuers of new car loans, Ford and Toyota.

.

Because used car loans are inherently risker to underwrite than new car loans KMX charges a higher interest rates and expects a higher spread.

6

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Auto Loan Delinquency Performance

KMX SC F TM GM

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

16.00%

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Auto Loan Net Loss Performance

KMX SC F TM GM

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

16.00%

18.00%

20.00%

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Auto Loan Interest Rate

KMX SC F TM GM

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

16.00%

18.00%

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Auto Loan Spread Capture

KMX SC F TM GM

August 21st, 2015 Analyst: redcards

While KMX is not capturing the high, low-teens spread like Santandar or GM Financial, the company is capturing almost triple what Ford and Toyota are able to generate. With the same low-risk profile of new car loans, KMX is able to capture the higher spread of used car loans at 5.1%. KMX does not begin earning net cash flow until the overcollateralization target is reached on the securitization. The overcollateralization is a cash reserve that KMX would use to pay off investors in the event of default. Currently, KMX overcollateralization target is 60bps, or $6.9m. KMX has historically never defaulted on any of their loans, and have never had to tap into their cash reserve collateralization to pay back investors. Because of this, the banks are able to reward CarMax’s track record with lucrative debt financing that other auto loan financers cannot match due to the high risk associated with their subprime customers. IR commented that it typically takes up to 4 months for a new ABS to become fully overcollateralized, but modeling the cash flow of their most recent ABS shows that overcollateralization was reached in under two months.

KMX has historically chosen not to finance subprime auto-loans for customers with higher risk credit profiles. The cash flow generating ability of KMX’s auto loans should drive auto loan receivables by an 11.2% CAGR, and CAF Income by a 15.7% CAGR.

Starting mid-2014, KMX initiated a subprime lending test for customers they historically referred to a banking partner. Per discussions with IR, it is 66% more profitable for CarMax to fund these subprime customers themselves rather than refer them for financing. However, in order to maintain the track record of their auto-loan securitization transactions, KMX will be funding subprime loans with on-balance sheet transactions. To-date the company has funded $110mm worth of subprime loans. Management has not made it clear whether or not subprime lending will become a premenant part of KMX’s business, but if it does, the company is well capitaized in preperation for assuming a larger on-balance sheet debt load. 7

ABS Cash Flow

Class A-1 Notes Class A-2 Notes Class A-3 Notes

Distribution Date Month 202,000,000 384,000,000 384,000,000

Closing Date 1 2,781,540 0 0

Jun-15 2 4,255,388 0 0

Jul-15 3 3,841,286 0 0

Aug-15 4 1,937,140 0 0

Sep-15 5 759,156 101,303 0

Oct-15 6 149,910 798,756 0

Nov-15 7 9,213 2,013,106 0

Dec-15 8 0 3,096,974 0

Jan-16 9 0 3,549,118 0

Feb-16 10 0 3,369,887 0

Mar-16 11 0 2,933,178 0

Apr-16 12 0 2,038,028 0

May-16 13 0 1,215,864 0

Jun-16 14 0 638,237 0

Jul-16 15 0 288,585 0

0.0

100.0

200.0

300.0

400.0

500.0

600.0

700.0

800.0

900.0

2016E 2017P 2018P 2019P 2020P

CA

F In

com

e (

$ in

mm

)

KMX CAF Income Projections

0.0

2,000.0

4,000.0

6,000.0

8,000.0

10,000.0

12,000.0

14,000.0

16,000.0

2016E 2017P 2018P 2019P 2020P

Au

to L

oan

Re

ivab

les

($ in

mm

)

KMX Auto Loan Receivables Projection

August 21st, 2015 Analyst: redcards

The company’s debt capacity peaked in 2009 with a net debt amount of $196.5mm and net debt/EBITDA ratio of 1.2x.

Using those figures as a guide, KMX’s current net debt/EBITDA ratio of 0.2x, and the rate at which KMX has funded their to-date subprime auto-loans – the company will be able to fund an additional $1.4b worth of subprime auto-loans before stressing historical debt capacity levels. This provides KMX with a runway of 10-12 years of subprime auto loan financing.

KMX retains the opportunity to refer subprime customers to their current bank partners for financing if the company feels an individual risk profile is too risky. Through the projection period of 2020P, KMX should be able to drive free cash flow generation 68% from $743m to $1.3b.

Large share repurchasing programs will be a driver of value in KMX’s stock through the projection period. Historically, KMX has not participated in buyback programs, but since return on invested capital has been strong, the company began buying back stock in 2012. Since then, the company has authorized multiple share-repurchase programs through the end of 2016. $2.25b expires at the end of 2016, and should lower shares outstanding by 31.9 million.

The lower share count will drive a 65% increase in FCF/share from $3.92 to $6.48, and also result in a 9.6% average FCF yield.

8

0.0

200.0

400.0

600.0

800.0

1,000.0

1,200.0

1,400.0

2016E 2017P 2018P 2019P 2020P

Fre

e C

ash

Flo

w (

$ in

mm

)

KMX Free Cash Flow Projection

-0.4

-0.3

-0.2

-0.1

0.0

0.1

0.2

0.3

0.4

0.5

0.6

2010 2011 2012 2013 2014 2015

Ne

t D

eb

t/EB

ITD

A

KMX Net Debt/EBITDA

0.0

200.0

400.0

600.0

800.0

1,000.0

1,200.0

2010 2011 2012 2013 2014 2015

KMX EBITDA

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

10.0%

11.0%

12.0%

2016E 2017P 2018P 2019P 2020P

Yie

ld (

|%)

KMX FCF Yield Projection

$2.50

$3.50

$4.50

$5.50

$6.50

$7.50

2016E 2017P 2018P 2019P 2020P

FCF/

Shar

e (

$ in

do

llars

)

KMX FCF/Share Projection

0.0

50.0

100.0

150.0

200.0

250.0

2015 2016E 2017P 2018P 2019P 2020P

Dilu

ted

Sh

are

s O

uts

tan

din

g ($

in m

m)

KMX Shares Outstanding Projection

August 21st, 2015 Analyst: redcards

Appendix II: Auto Loan Securitization Deep Dive Asset backed securitization (ABS) of auto loans is one of the oldest and most active securitization sectors. Since the 1980s, securitization has proved to be an attractive and efficient source of funding for auto finance companies. As investors showed growing acceptance of the ABS market in the 1990s, the economics of it brought new issues that included smaller, specialty finance firms, as well as lenders in nonprime borrowers. Additionally, consumers opted to lease new cars in increasing numbers over time, and this led to more auto lease ABS transactions. Auto ABS issuers can be divided into five broad groups: the Detroit Three (General Motors, Chrysler, and Ford), foreign automakers, bank lenders, independent finance companies, and subprime lenders. KMX would fall under the umbrella as an independent finance company. The auto finance sector has witnessed considerable consolidation over the years, especially among lenders to nonprime borrowers. Auto ABS also does not share the same stigma as MBS. Between 2007-2009, lenders experienced minimal defaults and losses on auto loans and leases, and overall the Auto ABS market did not see the same collapse as the MBS market. KMX facilitates these securitizations as off-blance sheet transactions through an organization structure of various special interest vehicles (SPV), where CarMax Business Services structures each transaction, and CarMax Auto Funding acts as depositor and seller of the securities to CarMax Auto Owner Trust. The securities are underwritten by Barclays Capital. J.P. Morgan, and Wells Fargo as asset-backed securities for sale to investors. In 2015, KMX financed 243,254 vehicle sales with an average credit score of 701.

KMX issues up to four auto securitizations per year, most recently ABS 2015-2, and collects the cash flows from the excess spread earned.

The capital structure of the auto securitizations are divided into separate tranunches based on the credit profile of the auto loans packedged. The highest quality loans are packed in Class A notes, while the worst quality are packed in Class D. In addition, the higher quality notes are subject to signifigantly lower interest fees, while the lowest quality are subject to the highest. 9

Contracts Originated by CarMax Auto

FInance

CarMax bundles the contracts and transfers them to

a bankruptcy remote Special Purpose Entity

(SPE)

SPE transfers contracts

into an Asset Backed

Securities (ABS) Trust

ABS Trust uses the contracts

as collateral for corporate

bonds that are sold to

investors

CarMax earns net

cash as the issuer of the

bond transaction

Loan Origination

2010 2011 2012 2013 2014 2015

Net loans originated 1,836.9 2,147.4 2,842.9 3,445.3 4,183.9 4,727.8

Vehicle units financed 109,030.0 120,183.0 152,468.0 179,525.0 218,706.0 243,264.0

Penetration rate 29.9% 29.7% 36.7% 39.4% 40.9% 41.2%

Weighted average contract rate 9.5% 8.7% 8.8% 7.9% 7.0% 7.1%

Weighted average credit score - - - 696 702 701

Weighted average term (months) 64.2 64.5 65.3 65.9 65.4 65.4

ABS Capital Structure

Initial

Principal

Amount

Interest

Rate

Final

Distribution

Months to

Distribution

Class A-1 asset backed notes 202,000,000 0.35% 16-May-16 13

Class A-2a asset backed notes 192,000,000 0.82% 15-Jun-18 38

Class A-2b asset backed notes 192,000,000 1.05% 15-Jun-18 38

Class A-3 asset backed notes 384,000,000 1.37% 16-Mar-20 59

Class A-4 asset backed notes 116,945,000 1.80% 15-Mar-21 71

Class B asset backed notes 23,300,000 2.15% 15-Mar-21 71

Class C asset backed notes 23,300,000 2.39% 15-Mar-21 71

Class D asset backed notes 31,455,000 3.04% 15-Nov-21 79

Total 1,165,000,000

Overcollateralization target 6,990,000

Overcollateralization percentage 0.60%

August 21st, 2015 Analyst: redcards

Class A notes hold senior precedence and have payouts maturing the earlierst – all within 2.5 years of securitization issuance. Per the legal structure of each transactions, paydowns to subsequent note Classes cannot begin until the preceeding Class has been fully paid off.

Under this structure [using securitization 2015-02 as an example], 50% of a $1.2b securitization is paid off in under 2.5 years, as opposed to the total time-to-maturity of 5 years.

The distributions of cash flows for KMX’s auto loans are set at recurring monthly intervals.

The two most important measures of performance for auto securitizations are net loss and delinquency rates. Below is an illustration for how both of those metrics perform for KMX.

KMX’s delinquency and net loss performance are both top tier in the industry. Both historical delinquency rate and net loss rate do not exceed 2%. 10

0.00%

0.20%

0.40%

0.60%

0.80%

1.00%

1.20%

1.40%

1.60%

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48

Ne

t Lo

ss (

as

a %

of

wh

ole

)

Months since Cut-off Date

KMX Cumulative Static Net Loss Performance

Net Losses

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

3.00%

3.50%

4.00%

4.50%

5.00%

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48

De

linq

ue

nci

es

(as

a %

of

wh

ole

)

Months since Cut-off Date

KMX Auto Loan Delinquency Performance

31-60 Past Due 61-90 Past Due 91+ Past Due

Class A-1 Notes Class A-2 Notes Class A-3 Notes Class A-4 Notes

Weighted Average Life (in Years) to Call 0.28 1.09 2.48 3.70

Weighted Average Life (in Years) to Maturity 0.28 1.09 2.48 3.74

Class B Notes Class C Notes Class D Notes

Weighted Average Life (in Years) to Call 3.91 3.91 3.91

Weighted Average Life (in Years) to Maturity 4.26 4.48 4.87

CarMax customers make monthly loan

payment

ABS Trust uses this monthly cash flow to repay bond investors

CarMax earns the difference between

the interest rate of the customer and the

investor payout as net spread

August 21st, 2015 Analyst: redcards

An ambiguous part of KMX’s securitization business is the treatment of their financing on the balance sheet. ABS financing is an off balance sheet event that takes place through a bankruptcy remort Special Purpose Vehicle (SPV), but due to GAAP regulations, CarMax is required to report non-recourse securitization transactions as an on balance sheet event. KMX utilizes non-recourse financing for their securitizations, and due to the nature of this debt shareholders and the company are not liable, or held responsible, for anything other than the cash reserve that is funded by the overcollateralization target. So, effectively, KMX’s non-recourse debt should be exclucded from total enterprive value (TEV) calculations, as investors are not purchasing the debt. Below is an example of KMX capital structure with and without the inclusion of their non-recourse debt.

Most notable is the change in Net Debt/EBITDA values. Including securitization yields a value of 8.2x, while excluding yields a value of 0.2x. 11

Capital Structure ($mm)

2010 2011 2012 2013 2014 2015

Excluding Securitizations

Shareholders' equity 1,933.6 2,239.2 2,673.1 3,019.2 3,317.0 3,156.8

Current liabilities:

Short-term debt 0.9 1.0 0.9 0.4 0.6 0.8

Current portion of long-term debt 122.3 0.0 0.0 0.0 0.0 10.0

Current portion of capital lease obligations 0.0 12.6 14.1 16.1 18.5 21.6

Non-current liabilities:

Long-term debt 27.3 0.0 0.0 0.0 0.0 300.0

Finance and capital lease obligations 0.0 367.6 353.6 337.5 315.9 306.3

Total capital 2,084.1 2,620.5 3,041.7 3,373.1 3,652.0 3,795.4

D/E ratio 0.1 0.2 0.1 0.1 0.1 0.2

Net debt 132.2 340.1 (74.0) (94.4) 292.9 259.8

Net debt/EBITDA 0.2 0.5 (0.1) (0.1) (0.3) 0.2

Including Securitizations

Shareholders' equity 1,933.6 2,239.2 2,673.1 3,019.2 3,317.0 3,156.8

Current liabilities:

Short-term debt 0.9 1.0 0.9 0.4 0.6 0.8

Current portion of long-term debt 122.3 0.0 0.0 0.0 0.0 10.0

Current portion of capital lease obligations 0.0 12.6 14.1 16.1 18.5 21.6

Current portfion of non-recourse notes payable 0.0 132.5 174.3 182.9 223.9 258.2

Non-current liabilities

Long-term debt 27.3 0.0 0.0 0.0 0.0 300.0

Finance and capital lease obligations 0.0 367.6 353.6 337.5 315.9 306.3

Non-recourse notes payable 117.9 3,881.1 4,509.8 5,672.2 7,024.5 8,212.5

Total capital 2,201.9 6,634.1 7,725.8 9,228.2 10,900.4 12,266.0

D/E ratio 0.1 2.0 1.9 2.1 2.3 2.9

Net debt 250.1 4,353.8 4,610.0 5,759.7 6,955.5 9,081.6

Net debt/EBITDA 0.5 6.1 5.9 6.9 7.5 8.2

August 21st, 2015 Analyst: redcards

As a result of KMX reporting securitization financing on its balance sheet, cash flow from operations is mistakenly lowered by working capital changes in auto loan receivables. The net cash flow from securitization financing is also included in Cash Flow from Financing Activities, and because of this automated research databases such as Bloomberg, Capital IQ, and FactSet do not make the adjustement to operating cash flow.

The difference between issuance and payments of non-recourse notes payable should be added back to operating cash flow as net cash.

The result is that KMX’ cash flow is actually a lot stronger than it would appear from their financials. Conversations with company IR confirm that this is the correct way to think about CarMax’s cash flow. The bulk of ABS cash flow is captured through higher credit quality Class A-1 through Class A-3 classifications.

Modeling a full auto securitization shows that CarMax captures a net spread of 5.1% while generating superior returns on invested capital of 29.0%

12

Effect on Spread Capture

0.1% 1.1% 2.1% 3.1% 4.1%

5.2% 5.1% 4.1% 3.1% 2.1% 1.1%

6.2% 6.1% 5.1% 4.1% 3.1% 2.1%

7.2% 7.1% 6.1% 5.1% 4.1% 3.1%

8.2% 8.1% 7.1% 6.1% 5.1% 4.1%

9.2% 9.1% 8.1% 7.1% 6.1% 5.1%

Auto Loan

Interest Rate

Bondholder Payout

ABS Cash Flow Summary

Class A-1 Class A-2 Class A-3 Class A-4 Class B Class C Class D

Cash flow 13,733,632 20,201,245 21,951,344 6,170,620 1,149,389 1,094,218 1,275,477

Overcollateralization 6,990,000

Total cash flow 58,585,925

Cash Flow from Financing Activities ($mm)

2010 2011 2012 2013 2014 2015

Increase in short-term debt, net 0.0 0.1 (0.1) (0.6) 0.2 0.2

Issuance of long-term debt 606.5 243.3 - - - -

Payments of long-term debt (793.0) (364.9) - - - -

Proceeds from revolving line of credit and long-term debt - - - - - 985.0

Payments on revolving line of credit and long-term debt - - - - - (675.0)

Cash paid for issuance of long-term debt - - - - - (1.2)

Payments on finance and capital lease obligations - (11.1) (12.6) (14.1) (19.6) (18.2)

Issuance of non-recourse notes payable - 3,348.0 5,130.0 5,851.0 6,907.0 7,783.0

Payments on non-recourse notes payable - (3,160.7) (4,459.6) (4,680.0) (5,513.6) (6,560.8)

Repurchase and retirement of common stock - - - (203.4) (307.2) (917.0)

Equity issuances, net 31.3 38.3 15.6 63.4 39.0 82.5

Excess tax benefits form share-based payment arrangements 3.9 8.9 9.7 24.1 22.6 50.1

Net cash provided by financing activities (151.3) 101.8 683.1 1,040.4 1,128.4 728.6

Cash from Operations ($mm)

2010 2011 2012 2013 2014 2015

Net cash provided by operating activities 50.3 (6.8) (62.2) (778.4) (613.2) (968.1)

Net issuance non-recourse notes payable - 187.3 670.4 1,131.0 1,393.4 1,222.2

Adj. cash provided by operating activities 50.3 180.5 608.3 392.6 780.2 254.1

Principal $1.2b

Time to maturity 5.5 years

Time to net cash flow 1.5 months

Overcollateralization target $6.9m

Interest rate 7.2%

Bondholder payout 2.1%

Spread captured 5.0%

Interest expense -4.0%

Loss allowance -3.4%

Direct expenses -9.7%

Total capital employed $22.3m

ROIC 29.0%

Auto Loan Securitization Economics

August 21st, 2015 Analyst: redcards

Appendix III: Valuation

I valued KMX on 2017P FCF. A composite of high quality American and Chinese automotive retailers, manufacturers, lenders, and auctioneers trade at an average 15x FCF. My base case 15x FCF scenario both embeds conservatism and margin of safety into the expected IRR considering KMX currently trades at 10x 2017P FCF. While assessing an appropriate peer group for comparison to KMX a collection of financial firms was also considered given the heavy lending nature of the Company’s business. On various metrics including P/E (TTM), EV/EBIT (TTM), P/FCF (TTM), Gross Margin (TTM), Net Margin (TTM, and ROIC (TTM) I concluded that KMX is more closely related to peers in the automotive industry rather than the financial space.

13

$59.58

$86.20

$109.55

$55.08

$0.00

$20.00

$40.00

$60.00

$80.00

$100.00

$120.00

Today Base Bull Bear

KMX Valuation Scenarios

Upside / Downside 45% 84% -8%

FCF per share $5.75 $6.26 $4.59

FCF multiple 15.0x 17.5x 12.0x

IRR 7.7% 13.0% -1.6%

Comparable Peers

Company Ticker Market Cap

Enterprise

Value P/E (TTM)

EV/EBIT

(TTM) P/FCF (TTM)

Gross

Margin

(TTM)

Net Margin

(TTM) ROIC (TTM)

AutoNation, Inc. AN $7.1b $9.0b 16.8 10.7 25.1 15.7% 2.2% 35.3%

Lithia Motors Inc. LAD $2.9b $4.7b 19.2 18.4 - 15.2% 2.5% 14.4%

Penske Automotive Group, Inc. PAG $4.5b $8.6b 15.3 14.9 16.7 14.9% 1.7% 13.9%

Ford Inc. F $57.9b $123.7b 18.8 23.5 7.1 12.5% 2.2% 6.4%

Toyota Motor Corp. TM $213.3b $335.5b 10.7 12.5 - 19.8% 8.0% 20.4%

Asbury Automotive Group, Inc. ABG $2.5b $3.9b 22.9 16.6 - 16.4% 1.9% 15.0%

GM Motors Company GM $50.4b $75.0b 14.7 12.4 14.6 9.9% 3.0% 22.2%

Group 1 Automotive GPI $2.1b $4.7b 16.7 15.8 - 14.5% 1.2% 12.3%

Genuine Parts GPC $12.4b $13.3b 17.6 11.5 16.3 29.8% 4.6% 17.0%

KAR Auction Services KAR $5.2b $6.8b 25 16.1 18.7 44.1% 8.5% 6.4%

China Auto Logistics CALI $3.7m $153.1m - - 9.7 0.9% -7.4% -13.7%

Sonic Automotive SAH $1.1b $3.2b 13.9 15.6 - 14.7% 0.4% 9.6%

Average - - 17.4 15.3 15.5 17.4% 2.4% 13.3%

CarMax, Inc. KMX $12.4b $14.2b 19.7 14.7 15.1 13.3% 4.2% 29.4%

Adj. Average - - 18.6 15.0 15.3 - - -

Santander Consumer Inc. SC $8.4b $38.1b 8.7 26.5 - 14.7% 19.9% 3.0%

Bank of America Corp. BAC $168.5b 302.6b 17.3 17.8 6.5 - 13.8% 3.0%

Royal Bank of Canada RY $79.8b $78.4b 11.3 7.7 6.8 - 26.7% 25.4%

Barclays PLC BCS $66.5b $164.8b 40.1 82.4 - - 2.2% -0.4%

J.P. Morgan JPM $235.2b $196.2b 11.5 6.4 4 - 23.9% 10.8%

Credit Suisse CS $43.9b $147.7b 11.7 27.4 4.1 - 14.4% 2.4%

Ally Financial ALLY $10.3b $81.1b 8.9 70.8 2.9 - 30.2% 0.9%

Average - - 15.6 34.1 4.9 14.7% 18.7% 6.4%

CarMax, Inc. KMX $12.4b $14.2b 19.7 14.7 15.1 13.3% 4.2% 29.4%

Adj. Average - - 17.7 24.4 10.0 - - -

CarMax Retail 2015 2017P CAGR

Retail units 590,224.0 720,706.4 10.5%

Retail average selling price (ASP) 23,585.5 23,803.9 0.5%

Retail gross profit per unit (GPU) 2,840.8 2,993.0 2.6%

CarMax Auto Finance (CAF) 2015 2017P CAGR

Interest and fee income ($mm) 604.9 852.9 18.7%

CAF income ($mm) 367.3 546.0 21.9%

Non-recourse notes payable, net ($mm) 1,222.2 1,742.2 19.4%

Auto Loan Securitizations 2015 2017P CAGR

Average interest rate 7.1% - -

Bondholder payout 2.1% - -

Spread captured 5.0% - -

Return on invested capital (ROIC) 29.0% - -

FCF Multiple

2017P FCF per share $5.75 10.0%

Applied FCF multiple 15.0x 3.0%

Price target $86.20 16,304.2

Upside / downside 44.7% 259.8

IRR (Present to 2017P) 7.7% 16,044.4

176.9

$90.70

52.2%

8.8%

Base Case Drivers

Base Case Methodology

Discounted Cash Flow

WACC

Long-term growth

Upside / downside

IRR (Present to 2017P)

Enterprise value ($mm)

Net debt ($mm)

Equity value ($mm)

Shares out. (mm)

Price target

August 21st, 2015 Analyst: redcards

Appendix IV: Discounted Cash Flow Although not the primary method of valuation used for CarMax’s target price, a discounted cash flow analysis was still conducted to cross check my multiples valuation results.

Appendix V: Financials

14

Free Cash Flow ($mm)

2016E 2017P 2018P 2019P 2020P

Net income 669.5 725.3 808.9 894.5 970.8

D&A 126.0 138.5 152.0 166.4 181.0

SBC expese 78.7 86.5 95.0 104.0 113.1

Δ working capital -145.8 -243.4 -408.0 -207.7 -185.0

Auto loan receivables -1,393.7 -1,393.7 -1,286.7 -1,075.6 -744.9

Cash flow from operations -665.3 -686.8 -638.9 -118.4 335.0

Issuance of non-recourse notes payable 8,667.3 9,551.3 10,432.8 11,316.0 12,198.9

Payment of non-recourse notes payable -7,177.5 -7,809.2 -8,824.3 -9,971.5 -11,267.8

Net issuance of non-recourse notes payable 1,489.8 1,742.2 1,608.4 1,344.5 931.1

Adj. cash flow from operations 824.5 1,055.3 969.6 1,226.1 1,266.1

Capital expenditures -81.3 -38.7 -15.5 -15.5 -15.5

Free cash flow ($mm) 743.2 1,016.6 954.1 1,210.6 1,250.6

Shares outstanding (mm) 208.8 176.9 176.9 176.9 176.9

Free cash flow per share $3.56 $5.75 $5.39 $6.84 $7.07

Free cash flow yield 6.0% 9.6% 9.1% 11.5% 11.9%

Income Statement ($mm, except per share values)

2010 2011 2012 2013 2014 2015 2016E 2017P 2018P 2019P 2020P

Sales & Operating Revenues:

Used vehicle sales 6,192.3 7,210.0 7,826.9 8,747.0 10,306.3 11,674.5 13,079.5 14,525.1 16,025.5 17,600.6 19,242.2

New vehicle sales 186.5 198.5 200.6 207.7 212.0 240.0 229.4 216.6 209.9 209.7 208.2

Wholesale vehicle sales 844.9 1,301.7 1,721.6 1,759.6 1,823.4 2,049.1 2,137.7 2,263.8 2,465.1 2,682.8 2,864.9

Other sales and revenues 246.6 265.3 254.5 248.6 232.6 305.1 300.2 301.7 303.2 304.7 306.2

Net sales 7,470.2 8,975.6 10,003.6 10,962.8 12,574.3 14,268.7 15,746.7 17,307.1 19,002.7 20,797.8 22,621.6

Cost of sales 6,371.3 7,674.3 8,624.8 9,498.5 10,925.6 12,381.2 13,605.2 14,953.3 16,418.3 17,969.3 19,545.1

Cgross profit 1,098.9 1,301.2 1,378.8 1,464.4 1,648.7 1,887.5 2,141.6 2,353.8 2,584.4 2,828.5 3,076.5

CAF income 175.2 220.0 262.2 299.3 336.2 367.3 458.0 527.1 576.0 626.7 629.2

SG&A 792.2 878.8 940.8 1,031.0 1,155.2 1,257.7 1,448.7 1,644.2 1,805.3 1,975.8 2,149.1

Interest expense 36.0 34.7 33.7 32.4 30.8 24.5 34.8 46.2 60.7 66.5 72.3

Other (expense) income 0.6 0.5 0.5 1.1 (1.5) (3.3) (0.2) (0.2) (0.2) (0.3) (0.3)

Income before taxes 446.4 608.2 666.9 701.4 797.4 969.3 1,115.9 1,189.9 12,940.2 1,412.7 1,484.1

Income tax provision 168.6 230.7 253.1 267.1 304.7 372.0 446.3 476.0 517.7 565.1 593.7

Net income 277.8 377.5 413.8 434.3 492.6 597.4 669.5 714.0 776.5 847.6 890.5

Earnings per share $1.25 $1.66 $1.79 $1.87 $2.16 $2.73 $3.78 $4.04 $4.39 $4.79 $5.03

Diluted shares outstanding 222.2 227.6 230.7 231.8 227.6 208.8 176.9 176.9 176.9 176.9 176.9

Discounted Cash Flow Analysis

Discount rate 10.0%

LT growth rate 3%

2016E 2017P 2018P 2019P 2020P

Unlevered free cash flow 743.2 1,016.6 954.1 1,210.6 1,250.6

Terminal value 18,401.7

Total 743.2 1,016.6 954.1 1,210.6 19,652.3

Enterprise value 16,304.2

Net debt 259.8

Equity value 16,044.4

Shares outstanding 176.9

Share price $90.70

Current price (8/21/15) $59.58

Upside/downside 52.2%

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