Fool on the Street: Sticker Shock at Conn's

Conn's recently presented at Southwestern Showcase 2007, an annual event held in Dallas during November. Check here for a list of presenting firms; most also provided a recording of their presentations. I'll be providing a recap of the events I attended, so be sure to check The Motley Fool's daily headlines for updates.

At a current price of $18.10, shares of electronics retailer Conn's (Nasdaq: CONN) are trading at less than 10 times earnings expectations for its fiscal year ending January 2008. That's quite a low earnings multiple for any company, and it appears downright cheap compared to Conn's larger peers Best Buy's (NYSE: BBY) trading at a 14.3 multiple, while Circuit City (NYSE: CC), which isn't even expected to post a profit this year. Of course, a P/E ratio is one of many metrics with which to evaluate and compare firms, and Conn's has a many characteristics worth investigating before we can decide whether the stock's a steal right now.

I've been tracking Conn's for some time, and I recently heard the company present at Southwestern Showcase, and sat down with CFO David Rogers to learn more. Here's what I found out.

A successful regional player
For Fools not familiar with the company, Conn's is a regional retailer with stores in Louisiana and Texas, and a planned presence slightly north in Oklahoma. Electronics and home appliances currently account for 65% of sales, with furniture, mattresses, and lawn and garden products accounting for the rest. Furniture is a relatively new merchandise category, and it's being earmarked as another growth avenue.

Rogers mentioned that Conn's plans to open 12 stores between now and July 2008 -- an aggressive turn in its expansion plans. But overall, the company is taking a measured approach, with future plans to grow into West Texas towns along the Mexican border. After that, it has plans to move further west, eventually reaching California. However, Conn's does not believe it has hit the saturation point in existing markets, and it thinks it should be able to expand, thanks in part to favorable population-growth trends as people move to warmer, more affordable Sun Belt states.

Despite Conn's regional focus, it estimates that it's already the ninth-largest appliance retailer, though it's only the 37th largest electronics retailer. In other words, it's quite a bit smaller than Best Buy or Circuit City, each of which operates more than 800 stores across the United States. Another key distinction is that Conn's, like big-box behemoth Target (NYSE: TGT), runs its credit operations in-house. This is big business to Conn's, since it extends credit for about 58% of sales.

Does Conn's deserve credit?
Credit is also a complicated business; Rogers explained that it requires evaluating the creditworthiness of each consumer, granting approval and loans to clients, and collecting on credit, which can grow quite cumbersome when accounts become delinquent. Conn's keeps close tabs on its clients, maintains statistics on product risk -- for instance, appliances carry lower credit risk than laptops -- and has two call centers, calling its riskiest portfolio of clients the day after an account hits the dreaded overdue status.

Conn's also securitizes its credit-card receivables, further details of which can be found here. These operations have proven the most difficult for investors to get their hands around, and recent turmoil in the credit markets caused the company to write down the value of its interests in its credit portfolio. This hit third-quarter earnings and sent the stock to a fresh 52-week low.

But overall, extending credit is probably worth the trouble -- it is very profitable, pushing Conn's operating margins above 8%, far exceeding Best Buy (5.3%), Sears (Nasdaq: SHLD) (4.4%), and Circuit City's negligible profitability. Certain investors consider credit and retailing two distinct businesses, but Conn's begs to differ; it sees both as vital in serving the interests of its clients, who tend to be blue-collar and carry lower credit scores. This may be seen as a disadvantage, but Conn's believes its close relationship with its client base and internal credit-tracking process actually reduce risk. The company's credit default rate usually tracks at less than 3% annually. Rogers mentioned that both business lines are profitable, meaning that the company's not selling merchandise at a loss to garner more lucrative credit revenue.

The Foolish bottom line
Given the fear circling the market in regard to financial companies with credit operations, it's not surprising that investors are running from Conn's. But with its low valuation and its steady approach to managing and expanding its store base, I'm seriously considering placing some chips on Conn's table. Running an in-house credit operation can be complicated, but trying to compete head-on with Best Buy has left many companies in ruins, including archrival Circuit City and regional players such as now-defunct Tweeter. That certainly should count for something, as should Conn's focus on targeting an underserved customer base.          

For related Foolishness:

• Does Conn's Deserve Credit?
• Conn's Blown Over