Will This Freak of Retail Nature Continue to Soar?

Compared to Best Buy and hhgregg, Conn's is defying logic, but should you be a buyer?

Jan 20, 2014 at 2:00PM

If you can find a retailer that's growing with good margins in this retail environment, then buy, hold it tight, and enjoy large returns. This philosophy explains why shares of Conn's (NASDAQ:CONN) are trading higher when peer Best Buy (NYSE:BBY) is sinking. However, given the large losses from the likes of Best Buy and hhgregg (NYSE:HGG), is Conn's still a buy?

Why a freak of nature?
Simply put: Conn's is a freak of nature. In a retail environment where goods are sold at break-even prices, and more consumers are gravitating toward e-commerce, Conn's has managed to grow solidly and produce margins that haven't been seen for the better part of the last decade.

If we look at Conn's last quarter, it grew revenue by 50.6% and continued its hot-streak of multiple quarters with same-store sales growth greater than 20%. Moreover, Conn's produced a gross margin of 40.1%, which was a 460 basis point rise over the prior year. With that said, a margin such as this implies that Conn's has a great competitive edge, and its growth is reminiscent of what we see with start-up companies.

Yet, Conn's isn't a new company -- it has been around for more than a century -- and earns its high profits by simply meeting the demand of today's consumer, something Best Buy and hhgregg might want to follow.

Specifically, Conn's does a few things differently than its peers. First, Conn's offers deliveries of its larger products. Second, Conn's offers a rent-to-own program, which is historically a risky business that is more of a hassle than it's worth. Yet, so far, it has worked well in the company's favor.

Lastly, Conn's has a very successful consumer-credit business, which generates substantial revenue and produces large margins. It is this business that really separates Conn's from Best Buy and hhgregg, as Conn's doesn't only loan to customers with perfect credit but also those with limited and even suspect credit histories.

These services combined are why more and more consumers are rushing in the doors of Conn's and how it's weathered the e-commerce storm.

On its own playing field
As previously mentioned, Conn's is on its own playing field, with nothing to compare; one look, or read, at what Best Buy management had to say about holiday sales further shows the almost unimaginable difference between these two companies

Here's the headline numbers from Best Buy: The company saw a 0.9% decline in comparable-store sales and now expects a 175 to 185 basis point decline to its fourth-quarter operating margin. Moreover, this is a company that over the last 12 months has produced an operating margin of 2.3% and in 2014 is expecting year-over-year revenue growth of just 0.3%.

For peer hhgregg, its net sales rose 7.6% during the holiday season, but comparable sales were lower by a whopping 11.2%. In 2014, hhgregg is expected to grow 1.2% and has an operating margin at 2%, which is very similar to Best Buy.

These numbers make Conn's look that much more impressive, as its 33% expected growth and 12.5% operating margin can not be duplicated. However, is it still a buy?

Is Conn's still a buy?
Best Buy rallied an incredible 240% in 2013 without any meaningful improvements. Essentially, Best Buy rallied because it was cheap, and investors/analysts believed that a turnaround was possible.

After Thursday's debacle, Best Buy now trades at 0.27 times sales; hhgregg is about half the price at 0.14 times sales, and both trade at forward P/E ratios below 15. Conn's, on the other hand, is a bit pricier, trading at 2.3 times sales and 17.5 times forward earnings.

Clearly, the reason that Conn's is priced higher is because of its growth, thus allowing for a valuation premium. In the last year alone Conn's has soared 140%, meaning that for gains to continue Conn's must keep growing.

As of now, the company's 20%-plus comps growth and its industry-best margins make it deserving of the premium, and with growth expected to continue, it's hard to imagine the stock trading significantly lower in the immediate future.

With that said, Conn's is an interesting stock to follow. While similar stores suffer, it continues to thrive. Yet, the real question is how long this trend can continue; Conn's will likely continue to soar so long as it maintains its fundamental performance, which as of now appears to be at least one more year.

Bottom line: A thriving retailer with strong growth and an industry-best margin is worth the premium.

2 more retailers to bet on for 2014
To learn about two retailers with especially good prospects, take a look at The Motley Fool's special free report: "The Death of Wal-Mart: The Real Cash Kings Changing the Face of Retail." In it, you'll see how these two cash kings are able to consistently outperform and how they're planning to ride the waves of retail's changing tide. You can access it by clicking here.

Brian Nichols owns Conn's. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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