Conn's: Pay Close Attention to Credit Metrics, Not Growth

Conn's (NASDAQ: CONN  )  soared higher on Monday June 2, 2014 after reporting earnings that beat expectations. However, the stock remains 40% lower year-to-date, as higher delinquency rates and growing concerns surrounding its in-house credit program continue to spook investors. Therefore, while Conn's continues to produce impressive revenue and profit growth, especially in comparison with peers Best Buy (NYSE: BBY  ) and hhgregg (NYSE: HGG  ) , let's look deeper within the quarter to see if the problems that led to such rapid stock losses are showing any noticeable improvements.

The most important question for Conn's
Conn's is a relatively small consumer products retailer that sells everything from electronics to mattresses. While peers such as Best Buy and hhgregg have struggled with negative same-store sales, Conn's announced growth of 15.2% for existing stores in the first quarter and revenue of $335.4 million .

With that said, Conn's doesn't have some great-kept secret to generating this growth. Instead, it's driven by an in-house credit program that has allowed the company to flourish, but could also lead to its doom.

Particularly, investors have a tendency to concentrate on lofty revenue growth figures and gross margin improvements. However, in regard to a company like Conn's the most important metrics are those that relate to its credit program, such as the percentage of delinquencies and how much growth is being created by in-house credit purchases.

To end the first quarter, the company's total outstanding balance was $1.1 billion, a year-over-year increase of 42%. Notably, this shows that much, if not all, of Conn's growth comes from consumers who are making purchases on credit. Therefore, the biggest question is whether those consumers are paying their bills, because if not, it falls back on Conn's.

A different kind of model
According to Conn's, 87,863 out of 631,795 total accounts are 60 days or more past due. In the fourth quarter of 2013, that number was 91,403 accounts, therefore it has dropped. Also, as a percentage of its total account balance, it comes to 8%, which is far better than the 8.8% the company announced to end the fourth quarter.

It appears that Conn's is making improvements and lowering its short-term risk while maintaining its growth. Essentially, the first quarter reflects a time when things went well for Conn's, and also shows how an in-house credit program can give it an edge against the likes of Best Buy or hhgregg.

Hhgregg clearly doesn't offer any credit programs, and its comparable sales decreased 9.9% in its first quarter . Hhgregg is a company with a stock price that has declined 42% in the last year alone, as it has been deeply affected by the rise of e-commerce.

Best Buy's comparable sales fell only 1.9% in its last quarter, but one reason why it performed decently was the 29% growth in its e-commerce business . Essentially, top brick-and-mortar consumer retailers like Best Buy operate in a new market where margins are non-existent and retailers must create any growth from a crowded online model. As a result, a business model can benefit from an in-house credit program, so long as it's firing on all cylinders.

Final Thoughts
Conn's has been able to avoid the hardships of its peers due to the edge provided by its credit program. While it showed some improvements in the first quarter, investors must remain cautious on the long term, and perhaps accept the fact that this is a model that may not be sustainable.

Specifically, if it were sustainable, wouldn't all retailers do it? Already, Conn's has shown a willingness to lower its standards in the face of rising delinquencies to attract growth. For example, in the first quarter of 2013, the average credit score was 596, but in the fourth quarter and in this most recent quarter, that average declined to 594 and 591, respectively.

Therefore, Conn's is taking on riskier consumers and a lot of longevity risk to create growth. This is not to mention that Conn's trades at 1.4 times sales, which is below the S&P 500 average, but far more expensive than Best Buy and hhgregg at 0.23 and 0.11 times sales, respectively. However, looking ahead, delinquency rates can change by the quarter as we have already seen. With Conn's becoming more lenient in its practices, the stock has all the makings of one that could crumble fast, and without warning.

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  • Report this Comment On June 13, 2014, at 5:03 PM, Violoncellist wrote:

    This analysis is very sound. CONN reminds me of BOST years ago where it produced nice "earnings" functioning largely as a bank, instead of a franchised restaurant chain -- IOW, CONN does "well" as a retailer largely because it isn't exactly what we usually mean by "retailer." Is it a buy here? If you believe the economy will continue to improve for its customer base, then yes. Credit quality is the name of the game here.

    -- One point I did want to mention is that IMHO the "average credit score" as mentioned in the article from 596 to 591 -- this decline is probably well within the "margin of error" of credit scores. While it might be compelling to think of this as an actual decline, from a strictly-statistical view it may very well just be an artifact of the "noise" inherent in the "credit score" valuation methodologies. It's only 5 points out of almost 600, after all.

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