Should Conn’s Be Following Rent-A-Center and Aaron’s Lower?

Conn's is following Rent-A-Center and Aaron's lower, but according to Piper, it shouldn't be; is Piper right?

Jul 22, 2014 at 3:23PM

Piper Jaffray issued a bullish note on Wednesday for shares of Conn's (NASDAQ:CONN), calling its five-day 15% loss unwarranted . The company's stock has clearly followed other retailers such as Aaron's (NYSE:AAN) and Rent-A-Center (NASDAQ:RCII) lower following poor fundamental related news. While Piper is bullish, should you be? Is the market making a wise observation?

What's the concern?
Aaron's, Rent-A-Center, and Conn's are all consumer electronics retailers, but operate very different business models. Rent-A-Center and Aaron's are comparable in that both companies cater to low-income consumers with limited or bad credit; neither require credit for rent or lease options.

Rent-A-Center allows consumers to rent merchandise with the option to buy, while Aaron's sells its goods in a lease format, meaning consumers have the option to buy or return goods following their term.

With that said, both Aaron's and Rent-A-Center have seen considerable stock weakness in the last week. Aaron's warned that its second quarter earnings would be shy of estimates due to soft demand with its low-income consumers. Specifically, it's expecting second quarter revenue at a midpoint of $673 million, or $5 million shy of expectations, and its EPS of $0.36 will be $0.10 below the consensus .

Rent-A-Center is experiencing similar problems, and it is discounting aggressively in order to maintain positive growth. Its expected $773 million in second quarter revenue is expected to fall $13 million short of expectations. However, the company hopes to find growth by offering smartphones rental without a credit check, deposit, or a long-term contract .

Where's the connection to Conn's?
With all things considered, Conn's is different from Aaron's and Rent-A-Center in the fact that while it offers in-house financing, it does require a credit check. Naturally, this removes some of the risk associated with the business model; Conn's sells rather than rents.

Therefore, according to Piper, Conn's recent stock losses in connection to Rent-A-Center and Aaron's poor performance is unwarranted. While true, Conn's stock has seen a 45% decline in 2014 alone due to higher-than-expected delinquent accounts.

While Rent-A-Center and Aaron's struggle for growth, Conn's produced double-digit comparable-store sales last year and is expecting comps to rise 5% to 10% this year . This performance has been a result of the company's in-house credit program, an initiative that increased the company's revenue from $800 million in 2012 to nearly $1.3 billion during the last 12 months. Operating margins have increased from 2.3% to 12.5% during the same period.

So long as the model holds up
Clearly, Conn's credit program has worked to its benefit. With its outstanding balance now exceeding $1.1 billion and 8% of this balance being 60 days or more past due, however, the company now has a lot of financial risk attached to its future .

So long as consumers are paying their bills on borrowed products, companies with this business model tend to perform well. Conn's is a perfect example, and Piper is correct in saying that the selling pressure is unjustified. In fact, if you're even considering an investment in Aaron's or Rent-A-Center, then Conn's has to look even better.

Conn's trades at just 10 times forward earnings vs. 12 and 10 for Aaron's and Rent-A-Center, respectively. Furthermore, Conn's has growth, and an $800 million business that existed prior to its in-house credit era, meaning that not all of the company's business is tied to credit, leasing, or renting.

Foolish thoughts
While investors must still pay close attention to the Conn's credit situation and the percentage of its balance that is not being paid, the company currently looks to be in a manageable situation. Furthermore, its 8% ratio of 60-days-or-more past due is a steep improvement from the 8.8% it saw at the end of 2013. Therefore, Conn's looks cheap, is still growing, and so long as more than 92% of credit customers are paying their bills, the company looks to be a good long-term investment opportunity.

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Brian Nichols has no position in any stocks mentioned. 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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