How Bad Credit Is Crushing Conn's, Inc. Stock

Shares are down 30% following Conn's second-quarter results. Here's what happened.

Sep 2, 2014 at 12:50PM

Revenue growth can be a telltale sign of a thriving business. But that certainly doesn't mean the market will applaud growth at any cost.

Conns

Credit: Conn's.

Case in point: Shares of Conn's (NASDAQ:CONN) plummeted more than 30% in Tuesday's early trading after the specialty retailer saw second-quarter revenue climb 30.4% year over year, to $353 million, or roughly in line with analysts' expectations. Some of that growth came from the opening of eight new Conn's HomePlus stores in seven markets during the quarter, while same-store sales simultaneously climbed 11.7%. For perspective, that marks the 12th consecutive quarter of increasing comps for Conn's retail operations.

However, Conn's adjusted earnings fell to $0.50 per diluted share, which was well below analysts' expectations for earnings of $0.76 per share.

So, what happened? According to Conn's CEO Theodore Wright, the blame lies with Conn's floundering consumer credit operations. Wright elaborated:

Overall results were not satisfactory. Our credit operations ran into unexpected headwinds, resulting in portfolio performance deterioration. Despite tighter underwriting, lower early stage delinquency and improved collections staffing and execution, delinquency unexpectedly deteriorated across all credit quality levels, customer groups, product categories, geographic regions and years of origination.

Worse yet, Conn's sees future 60-day plus delinquencies increasing to levels above historical highs in the third and fourth quarters. As a result, Conn's now expects full-fiscal year adjusted earnings in the range of $2.80 to $3.00 per diluted share -- a significant reduction from its previous guidance range of $3.40 to $3.70.

Don't be too surprised
At the same time, however, this isn't entirely shocking. After all, Conn's self-described business approach centers on first reaching the underserved segment of low-income consumers, then using its credit operations to give them the opportunity to purchase high-quality, big-ticket items like furniture, mattresses, electronics, and appliances with extremely low monthly payments. In the end, the fallout of a large number of those consumers defaulting on their credit obligations may as well have been taken directly out of the "risks" section of Conn's most recent annual report.

This doesn't mean Conn's is simply sitting on its heels as the situation worsens. "In response to the higher delinquencies," Wright says, Conn's is not only tightening underwriting, but also "reducing the level of no-interest programs and raising the interest rates in some markets to increase portfolio yield."

Of course, that approach is also a double-edged sword. An average of 70% of Conn's retail sales go through its in-house credit programs, and large portion of that credit portfolio goes to sub-prime borrowers. By tightening underwriting, reducing no-interest programs, and raising rates, Conn's could very well be dropping the fridge on its coveted revenue growth down the road.

In the end, though today's huge plunge might seem like an overreaction on the surface, that's why I can't blame the market for taking a huge step back from Conn's today. For now, I'm perfectly content watching Conn's from the sidelines.

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Steve Symington 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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