Should You Still Fear Conn's Going Into Earnings?

Conn’s is falling sharply on poor EPS estimates for the fourth quarter, but are recent weakness in mattress sales and the company’s failure to address revenue equally problematic?

Feb 25, 2014 at 3:00PM

Conn's (NASDAQ:CONN) has outperformed peers like Best Buy (NYSE:BBY) in recent years thanks to a successful credit program and impressive same-store sales performance in its major segments such as home appliances, furniture, consumer electronics, and home office. But it got crushed last Thursday after its credit program has backfired, causing the company to lower its earnings-per-share guidance. Yet, given the earnings performance of mattress companies like Select Comfort (NASDAQ:SCSS) and Mattress Firm Holding (NASDAQ:MFRM), should investors fear Conn's top-line performance when it reports earnings on March 27?

A longtime advantage backfires
Essentially, the Conn's advantage in recent years has been its much-debated credit program. Unlike peer Best Buy, Conn's offers its customers in-house financing, which then makes consumers more likely to buy -- but also exposes the company to a great deal of financial risk.

Given Conn's success, including 38% revenue growth in 2013 and expected 33% growth this year, many believe that Best Buy should have followed suit in offering financing. However, on Thursday we saw why this might not be a good idea, as soaring charge-offs and delinquencies in the fourth quarter had Conn's guiding for quarterly EPS of just $0.77 versus $0.93 expected.

Therefore, investors can clearly see that Conn's growth comes at a cost, and despite an industry-high operating margin of 12.5%, investors are showing zero faith in the company's ability to reverse these bad fortunes. In particular, many think the massive losses are a result of the company's willingness to approve risky consumers just to ensure top-line growth. However, that top-line growth might also be in question.

Heavily reliant on one industry
Conn's estimates for the fourth quarter only include profit; the company did not mention its top-line performance. As an investor, this fact might be very alarming, as there are certain reasons to believe that revenue could be soft for the quarter.

With that said, mattress and furniture sales are what really drove sales growth for Conn's over the last year. In particular, the company saw 95.7% year-over-year growth in its mattress and furniture division, which accounted for more than 20% of total third-quarter revenue.

This growth was driven by very impressive 40% growth in mattress volume to complement a 19% boost in the average selling price per unit. Combined, this performance helped Conn's grow its total revenue by 50% in the third quarter. Yet fundamental reports by mattress leaders might imply that the third quarter's performance was nothing more than a fluke.

Is revenue growth also at risk?
To explain, let's take a look at the earnings from two mattress leaders.

Select Comfort missed expectations on both the top and bottom lines, as revenue grew just 4.7% in the fourth quarter to $231 million. Furthermore, the company saw its operating income decline from $19.4 million in the fourth quarter of 2012 to just $9.7 million.

Then, while Mattress Firm's comparable-store sales rose 6.5% in the fourth quarter, including 20% total revenue growth, the company noted that volume was weak and that its operating margin declined 200 to 230 basis points in the quarter. This implies that pricing was poor, which contrasts the performance of Conn's in its third quarter.

Perhaps Conn's is immune to macro conditions and the pricing environment of the mattress industry. Yet given the financial results from Select Comfort and Mattress Firm, it does look as though pricing momentum within this space did not continue into the fourth quarter of 2013.

Final thoughts
Looking ahead, many might think that Conn's 35% stock decline following its EPS warning is taking into account poor sales as well. However, it's worth noting that at 1.8 times sales, Conn's trades at a steep premium to peer Best Buy at 0.2 times revenue, thus implying it still has far to fall.

With that said, Conn's margins and financing department are the only advantages separating it from its peers, and currently these areas are under pressure. As a result, investors should exercise extreme caution going into the company's quarterly results, because while the EPS warning is already priced into the stock, this weakness may only be half of the equation for this retailer.

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