Is Conn's, Inc. Destined for Greatness?

Investors love stocks that consistently beat the Street without getting ahead of their fundamentals and risking a meltdown. The best stocks offer sustainable market-beating gains, with robust and improving financial metrics that support strong price growth. Does Conn's (NASDAQ: CONN  ) fit the bill? Let's take a look at what its recent results tell us about its potential for future gains.

What we're looking for
The graphs you're about to see tell Conn's story, and we'll be grading the quality of that story in several ways:

  • Growth: Are profits, margins, and free cash flow all increasing?
  • Valuation: Is share price growing in line with earnings per share?
  • Opportunities: Is return on equity increasing while debt to equity declines?
  • Dividends: Are dividends consistently growing in a sustainable way?

What the numbers tell you
Now, let's take a look at Conn's key statistics:

CONN Total Return Price Chart

CONN Total Return Price data by YCharts.

Passing Criteria

3-Year* Change 

Grade

Revenue growth > 30%

59.2%

Pass

Improving profit margin

2,789.7%

Pass

Free cash flow growth > Net income growth

(383%) vs. 4,344.3%

Fail

Improving EPS

2,554.5%

Pass

Stock growth (+ 15%) < EPS growth

704.8% vs. 2,554.5%

Pass

Source: YCharts. *Period begins at end of Q1 (April) 2011.

CONN Return on Equity (TTM) Chart

CONN Return on Equity (TTM) data by YCharts.

Passing Criteria

3-Year* Change

Grade

Improving return on equity

2,750.7%

Pass

Declining debt to equity

(5.5%)

Pass

Source: YCharts. *Period begins at end of Q1 (April) 2011.

How we got here and where we're going
Conn's swings for the fences and sends a fat pitch out of the park in our assessment today, its six out of seven passing grades missing perfection only because the company has gone increasingly free cash flow negative during the past few years. Conn's was certainly helped by the fact that its bottom line was so close to zero at the start of our three-year tracking period, which inflated its net-income-based growth metrics, but it's hard to deny that there has been significant growth -- a retailer that can boost its profit margin from basically zero to nearly double digits in three years must be doing something right. However, investors shouldn't ignore Conn's free cash flow problems. Can the company move past this one glaring problem to achieve perfection next year? Let's dig deeper to find out.

Many investors and analysts have noted the discrepancy between Conn's net income and its free cash flow. While it might be tempting to write this off as the cost of expansion -- building new stores costs a lot of money -- this simply isn't the case. Conn's accounts receivable, which can impact operating cash flow in a major way, have soared during the past five years. To put this claim in perspective, let's compare it to similarly positioned retailer hhgregg:

CONN Accounts Receivable (Quarterly) Chart

CONN Accounts Receivable (Quarterly) data by YCharts.

Accounts receivable, for anyone who never bothered to take any accounting classes, are essentially as-yet-unpaid lines of credit extended by a business to its customers. This is an asset on balance sheets, but it can drag down free cash flow when recorded on the cash flow statement. In Conn's case, it can be the vast majority of assets, which is a dangerous position to be in should customers begin defaulting en masse, as occurred during the financial crisis. Fool consumer goods specialist Brian Nichols has delved much deeper into Conn's credit program, which has been the driving force behind the retailer's bottom-line growth (click here to read his analysis), and his conclusion is far from optimistic. Since Conn's has been one of the year's biggest losers, this view seems to be the dominant one on the markets thus far.

However, it's hard to deny that Conn's is doing an excellent job encouraging consumer spending, as its home goods sales shot higher in the first quarter, led by mattresses and other furniture. Even electronics sales grew in existing stores, which easily trounced hhgregg's results for the same period -- and hhgregg is the retailer better-known for its electronics offerings. Nichols has repeatedly pointed out that Conn's credit-driven growth heightens its risk as an investment, and credit may prove its undoing. Investors will need to carefully consider their faith in weak-credit borrowers -- the average Conn's borrower has a pretty lousy credit score -- before jumping into this former highflier.

Putting the pieces together
Today, Conn's has many of the qualities that make up a great stock, but no stock is truly perfect. Digging deeper can help you uncover the answers you need to make a great buy -- or to stay away from a stock that's going nowhere.

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9/15/2014 3:59 PM
CONN $29.39 Down +0.00 +0.00%
Conn's, Inc. CAPS Rating: **

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