Off-Center at Rent-A-Center

Renting a Hyundai Accent from your local car rental company for $190 a week doesn't rile up consumer advocates. But make a large-screen TV available for rental for $46 a week, along with an option to buy it, and you're charged with unconscionably preying upon the poor.

That's the problem Rent-A-Center (Nasdaq: RCII  ) and other rent-to-own businesses are facing. They provide access to products people wouldn't normally be able to afford, but they're accused of charging usurious and illegal interest rates. Increasingly, they're being taken to court. Rent-A-Center ended up reporting a fourth-quarter loss of $2.3 million on $656 million in revenues, mainly because of a $58 million reserve it set up for a lawsuit in which it's embroiled.

Without those litigation charges and expenses related to restructuring, Rent-A-Center would have reported earnings of $35.6 million, compared to the $33.6 million in adjusted earnings a year ago. While that would have meant flat earnings year over year, it would have been slightly better than the $0.49 per share analysts had expected.

Renting to own furniture, equipment, and appliances is not the most financially astute thing to do. Because the rental payments also include a portion set aside to defray part of the cost of the goods, you end up paying a lot more for the merchandise than you would if you just went to Sears (Nasdaq: SHLD  ) and bought it outright.

But that's just the thing. People who use the services of Rent-A-Center or Aaron Rents (NYSE: RNT  ) typically can't buy at Sears or Target (NYSE: TGT  ) , because they have poor or no credit, and those stores won't extend them credit. Some 72% of Rent-a-Center's New Jersey customers can't afford to purchase their household goods and appliances at a typical retailer, and they certainly can't pay cash for them, either.

The people using Rent-A-Center are being given immediate access to household goods and products at low rates, usually without any down payment or credit check. Not that the rent-to-own industry has these customers at their mercy. There's no right or privilege to owning a large-screen TV.

Yet it can't be denied that the rates charged by the companies over the course of the contract are, um, excessive. In the lawsuit that caused Rent-A-Center to set aside that large sum for "probable" losses, the court found that the interest on the contract exceeded 80% per year in some cases. That's obviously far above the 30% cap set by New Jersey law.

Rent-A-Center argued that its contracts were leases that didn't fall under the state's usury laws. Since there was no obligation to buy the products -- the plaintiff could simply walk away from the rentals by stopping payment and returning the products -- it did not constitute a retail installment contract. The state supreme court disagreed. Between 64% and 70% of Rent-A-Center's customers ultimately buy the product.

The rent-to-own industry, like payday lenders and subprime mortgage lenders, has a somewhat unsavory public persona. Rent-A-Center has encountered similar lawsuits elsewhere, forcing it to change its practices to comply with the law. That creates a lot of uncertainty now, and regardless of rising revenues, you can expect more legal challenges built upon the rulings in New Jersey.

For more on rental businesses, check out:

Rent-A-Center is a Motley Fool Inside Value recommendation. For more top-shelf stocks trading at bargain-basement prices, try our value-hunting newsletter service free for 30 days.

Fool contributor Rich Duprey does not own any of the stocks mentioned in this article. You can see his holdings here. The Motley Fool has a disclosure policy.

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Related Tickers

10/26/2016 4:00 PM
RCII $9.53 Up +0.11 +1.17%
Rent-A-Center CAPS Rating: **
RNT $30.02 Down +0.00 +0.00%
Aaron Rents CAPS Rating: **
SHLD $10.94 Down -0.27 -2.41%
Sears Holdings CAPS Rating: *
TGT $68.59 Up +0.64 +0.94%
Target CAPS Rating: ***